Why is the US dollar gaining ground?

Jan 30, 2015

- By Bill Bonner

Bill Bonner
Rancho Santana, Nicaragua

Dear Diary,

The Dow put in a good turnaround yesterday and Thursday, with another 225 increase today.

We don't know whether prices are going up or down. They usually go up and down, but we suspect they are going up and down even more.

This from Bloomberg:

    Equities trading has become more volatile amid signs that the plunging price of crude and a stronger dollar are eroding corporate profits. The S&P 500 dropped 1.4 percent Wednesday, bringing its slide this month to 2.8 percent, the most since January 2014. The Chicago Board Options Exchange Volatility Index jumped 32 percent in the previous two days, its biggest gain in almost seven weeks.
The Fed is no longer buying assets to keep up prices. It doesn't have to. The Europeans and Japanese are on the case. They're trying to lower the value of their own currencies. The idea is to make their exports more attractive (cheaper) overseas and raise prices at home.

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It's all nonsense, from an economic point of view. But it is not without real world consequences - some foreseeable and others not.

And here a moment of pause is appropriate. We take our cap off to Mr. Market and salute him. There must be 100,000 full time economic and financial analysts in the world. They are all watching, studying, and forecasting. But how many saw the price of oil falling below $50? Almost none. It was just unthinkable.

We remember 3 years ago, industry analysts proclaimed the "we will never see $50 oil again in our lifetimes."

And here it is: $50 oil.

And here's another one: who saw the ECB picking up the Fed's QE burden? Well, quite a few people, probably. But as you'll recall, the Fed announced its tapering off program. Gradually it would take its monthly purchases of bonds down to zero. This would remove about $1 trillion in purchasing power from the bond market. Many members of the commentariat predicted trouble - including us. How could you take the largest bidder out of a market and not expect prices to fall? Even if the ECB did come in with a big wallet, it wouldn't replace the Fed.

But prices did not fall. Or, at least they haven't fallen - yet. Those nice Italians, Dutchmen, and Portuguese began a buying program of their own - of 60 billion euros per month.

That alone probably didn't make so much difference. They are not buying US assets directly. But simultaneously, the dollar was rising. European and Japanese currency debasement, along with little or no growth in their economies, and a falling price of oil (in dollars) has driven up the dollar considerably. So, the European investor looks around and asks himself: which would I rather have, a French 10-year bond with a 0.53% coupon...in a currency that is losing value, or a US 10-year bond yielding 2.25% in a currency that is gaining ground? The dollar has gained about 10% on the euro over the last 6 months. Foreign investors have made a real return of more than 12% on US bonds in the last year (compared to, say, the French 10-year bond). No wonder they're buying. And no wonder US assets don't crash.

Who knew? Who warned you? Nobody at the Diary. These were the two biggest financial trends of the last 12 months. And almost nobody saw them coming.

It makes us wonder. What else is coming that we don't see?

Obviously, we don't have an answer to that. If we did, the question wouldn't make sense. But one thing we can predict with fair reliability - with so much intervention going on...so much new liquidity added to the world's asset purchasing power, and so many other strange financial phenomena, there are bound to be more unforeseen 'accidents' coming.

Maybe in the nearly $1 trillion of auto loans? Or, in the more than $1 trillion in student loans? Or the $4.6 of negative yield government debt (mostly in Europe's periphery states)?

It may be impossible to tell where and when, but with so much more gin dumped into the globe's punch bowl, you can probably expect more people to pass out.

Bill Bonner is the President & Founder of Agora Inc, an international publisher of financial and special interest books and newsletters.

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