Is the euro-bull move over? Is the gold bull therefore over as well? Whatever happened to that "super-currency" that is supposed to wipe out the dollar as the world's reserve currency of choice? Looks like it was all just a big hype job, right?
Not so. The euro's biggest strength is the fact that it can afford to be "weak." A rising dollar is no threat to it. In fact, the euro benefits tremendously from this current dollar rebound - and I humbly submit that the dollar rebound was engineered for exactly that reason: to allow the euro to further penetrate the world currency markets.
In the meantime, the strong dollar actually poses serious risks for US markets.
Is There Any Way Out for US Stocks?
While paper-gold investors are pulling out their hair, selling off their assets, and are running for the hills, the economic downturn they have bet on by buying gold-based lottery tickets is building all around them. The only thing is: they don't see it.
They know all about it, but they are totally demoralized by the recent drop in the smoke-and-mirrors COMEX market. Instead of looking at the spectacle of their every expectation being fulfilled in real-time, they look inward and bemoan their losses. They don't see the downturn because the market-riggers have masked it behind a wall of emotional pain built just for their benefit - and for the benefit of the mainstream investors who now can no longer see any alternative to stocks and bonds.
The reason why "mainstreamers" no longer see an alternative was explained in our last essay: Did Gold Stocks Threaten the Financial Order?. In short, the stock-market's exit doors had to be jammed to usher the herd into the only acceptable exit: dollar cash.
When we step back from that emotional smokescreen-wall and see how low and flimsy it really is, and how easy it is to see past and through it, what picture reveals itself to us?
Inflation is "back" (In truth, it has never left us, but the only way by which mortals can feel its effect - rising prices - is now taking center stage again.) The resulting higher US consumer prices, combined with the stronger dollar, push Americans to buy more cheap foreign goods, increasing the trade deficit.
The super-high trade deficit demands a lower dollar - but the dollar Is climbing, adding to the deficit. A stronger dollar decreases US export profits lowering corporations' balance sheets, putting downward pressure on stocks. This creates more incentives for US companies to go offshore to produce at lower cost and so puts downward pressure on US wages (our incomes), while consumer debt service costs rise due to higher interest rates.
At the same time, a stronger dollar is a threat to the stock market. You don't even need to understand why. The only thing you need to do is observe that every time we get "great" economic news these days (like how many jobs the President has "created" last month, etc.) stocks take it on the nose.
(As to the reasons why, there are several: higher rates raise companies' borrowing - and therefore operating - costs, decrease their export profits via a stronger dollar, and decrease consumption because they raise hocked-to-the-hilt consumers' debt service costs, depressing disposable [or investable] incomes.)
Meanwhile, the dollar keeps climbing, perpetuating this vicious cycle. If the dollar keeps rising due to the kind of dollar-short squeeze Rick Ackerman sees, then either the US housing or the stock bubble - or both - will burst. In addition US exporters will see profit margins shrink, causing them to downsize, lay off workers, go offshore, etc.
The big question is: When the stronger dollar pumps up the trade deficit, will foreigners start buying US assets again like they did in the nineties?
If so, the trade deficit will be "funded", the stock market can grow, bond yields (inverse to bond prices) will drop due to higher demand, easing pressure on US consumers debt servicing costs. Pressure on the Fed to further restrict credit by raising rates will ease, and the economic catastrophe of a collapsing debt-bubble will again be postponed.
That's the keyword here: postponed.
There is no "solution" to this mess, other than an honest to goodness catastrophe. Anything short of that would be "dishonest" - because the catastrophe can only be avoided by "dishonest" means (i.e., further rigging of the financial markets.) "Postponement" is actually the best-case scenario here.
Let's examine what happens if the powers are successful in postponing the inevitable yet again:
If foreigners can again be suckered into gobbling up US assets to fund the growing deficit, they will buy US real estate too, so the housing bust will be avoided - but the bubble will grow!
For how long will foreigners continue to buy? Only for as long as they see a benefit to it.
In the nineties, the benefit was that the dollar, and specifically US treasuries, were seen as the only real-life "safe havens" for otherwise at-risk funds. Bob Rubin's and Larry Summers' gold-suppression scheme made sure that gold was not considered as an alternative. Remember the Asian Contagion? Money just wasn't safe anywhere except in the US during those days.
But Now, There Is The Euro
And the euro benefits tremendously from this "dollar strength."
While the dollar is thus rising, Asian exporters, which during September 2003 through January 2004 have been the very last vestige of support fo the dollar internationally, can go back to doing what they like best these days: buying euros and euro-denominated assets.
That means this time it will be far harder for Uncle Al to suck foreign investment back into the US to finance the ever growing trade deficit. Foreigners now see the same danger in the deficit as they did during the late nineties, but now there are two problems: that deficit is a whole lot bigger, and they finally have an alternative inthe euro that simply didn't exist last time around.
On top of that, the world is now more "ambivalent" about US foreign policy than ever before. (That's a euphemism for "they hate our guts and would just as soon 'let us have it' economically, if only they could.")
Finally, Asian and European consumption patterns have shifted away from US goods. They now consume more of each others' products than ever before, which means they have developed, and continue to develop, alternative (non-US) markets for their products.
In short, any Fed rate hikes may well lead currency traders to buy more dollars in the short run, but foreigners will be far less likely to shift any big time funds back into buying US assets to fund the trade deficit in the long run - and that is the only thing that can forestall a dollar-rout int that time frame.
Since January, another important thing has happened:
Japan has found its economic footing again, thanks to its ultra-massive currency intervention of last year and the first two months of this year, and China has discovered that printing yuan to buy dollars causes inflation. (Welcome to the wonders of free-market economics, China!)
That means the formerly two biggest buyers of US Treasury debt now have far less incentive to continue doing so.
The net result:
The world will no longer finance the US trade and current account deficits. Ergo: the current dollar run-up has only currency speculators to support it.
Granted, speculators can be, and often are, most irrational in their speculations, and that irrationality can last for a very long time. We saw that most recently among stock buyers in the US since April/May of last year when the riskiest, fundamentally most worthless small cap stocks showed the biggest gains. But even they know that betting against the trend is a bad idea, and the long term trend for the dollar remains down, not up.
Bottom line: the euro has a high "gold-tolerance." The dollar doesn't. The euro has great actual worldwide demand even while traders bid up the dollar. The dollar experiences lower and lower worldwide demand whenever traders bid up the euro.
A low forex value is good for the euro because it allows the euro to propagate itself across the world financial landscape without negative consequences to the euro area economies. A low forex value is bad for the dollar because people simply see it as a reason to get out of the dollar.
In other words, the euro just doesn't happen to carry any risk of being sold off in a panic when it gets too low - but the dollar has that risk. If the dollar falls too low, people are tempted to dump it left and right, just like it almost happened in January this year.
It can therefore be said without reservation: the euro's greatest strength is its temporary weakness - and the dollar's greatest weakness is its (very temporary) strength.
The effect on gold of all this? Up, up, and away - after the dollar-bear reasserts itself. And that will happen much sooner than demoralized gold investors right now expect.