Rubino: A Troubled World Means A Stronger Dollar… For Now
You’d think that the more trouble the US causes around the world, the weaker the dollar would trade. Who, after all, wants to own the currency of the country perceived by most to be the source of today’s long list of trade conflicts and dirty wars?
Apparently everyone, in a dynamic that’s been defying logic for some time: When the US has and/or causes problems, the impact is even more severe overseas where a growing list of badly-run countries are either on the brink of financial ruin or heading that way fast.
So trouble of any kind anywhere sends terrified capital pouring into US Treasury bonds, resulting in a strengthening dollar…
…and plunging US Treasury yields. Here’s the 10-year:
A new-to-the-scene observer might see these trends as indicative of a country in good shape, with soaring demand for its paper serving as a global vote of confidence.
But this, like most trends positive involving fiat currencies and rising debt, is both deceptive and temporary, and will, if history is still a reliable guide, reverse suddenly and violently. Here’s one way it could play out:
A rising dollar makes it harder for US companies to sell goods – priced as they are in an appreciating currency – overseas. This lowers corporate profits, which spooks the stock market and produces a reverse wealth effect in which companies scale back capital spending and investors buy fewer cars, houses and luxury vacations. Economic growth, as a result, slows or reverses.
While this is happening, the dollar might actually continue to rise for a while as falling US stocks are seen as a bigger threat overseas than here at home, causing Russians, Chinese, Europeans and Latin Americans to step up their Treasury buying.
But the result is the dreaded “crowded trade” that usually fails once all the greater fools have bought in. Yesterday’s Wall Street Journal notes that the futures markets are pointing towards that outcome.
A persistently strong dollar is underpinning a rally in U.S. government bonds, as rising global trade tensions stoke demand for safer assets.
International investors typically hedge their holdings of foreign bonds using derivatives, which allow them to borrow foreign currency in exchange for their own, and lock in a future interest at which they will reverse the transaction.
[But] Some investors are wading into U.S. Treasurys without paying to protect themselves against fluctuations in the dollar, a bet that continuing U.S. economic strength and comparatively high interest rates will keep the currency grinding higher.
That marks a reversal from late last year, when the high cost of hedging against the dollar’s fluctuations kept some foreign investors out of U.S. debt and yields climbed to multiyear highs.
The strategy has rewarded investors who bet on the dollar recently, as the currency defied the expectations of many Wall Street banks by steadily appreciating to a recent two-year high.
But really They’re All Doomed
Short-term fluctuations in interest rates and currency exchange rates are interesting and maybe profitable for those brave souls willing to bet against crowded trades. But the overriding truth is that all fiat currencies are losing value, most at an accelerating rate. So “strong” currencies are only strong when measured against their weaker cousins. Measured against real things – farmland, oil wells, gold, silver – the long-term trend points to a single destination: fiat’s intrinsic value of zero.