The Dollar is on Life Support

The US Dollar is on life support folks. The really sad thing about this reality is that the dollar is being kept upright because quite literally there is no other place for money to go around the world. Money is flowing from risk on assets to the safety of US debt and its deep liquidity pool. Unlike 2008, this time this inflow of money isn’t propelling the USD index higher. In fact it is just barely keeping the dollar above its all time lows. Look at the chart and witness how rallies are sold to be followed by a test of support at 73.5. A failure at 73.5 brings the all time low of 72 into the crosshairs.

Where the Fed previously could engineer strong rallies with legs, either in the bond market or the stock market, and could manage gold prices by shaping expectations, they now can only create tepid flows rather than hot flows. Sustained rallies in the dollar fail and the stock market is bolstered, followed by de-risking and yet another weak rally in the dollar and plunging stock markets. Look at how the Fed has lost their mojo:

Here is the S & P performance over those rally periods and during this last sell off:

This inability of the dollar to rise substantially is a symptom of the terminal debt disease that afflicts the dollar. As debt continues to expand faster in the dollar than the other major currencies of the world, it counters the safe haven flow appreciation effect. Martin Armstrong sees this playing out to the degree that stock market will be unable to decline due to the creation of wave after wave of new dollars.

The Fed has painted itself into a corner: they cannot flood liquidity into the market through QE(n) because it is politically a hot potato now and because it will collapse the dollar through technical support, and they cannot allow the dollar to strengthen appreciably or it will destroy the stock market, Obama’s chance at re-election, and the perception that we are not in a global depression. So we trapped in a world where debt has to be acquired at nearly zero cost (all time high bond prices, all time low yields) and this juice keeps the dollar alive, avoiding death by sudden collapse of confidence or death by inflation.

Remember that the USD index measures the relative strength of the dollar to a basket of other major currencies. This chart is telling us that without the panic into the dollar,  the dollar would be the weakest major currency around. This is exactly what the Fed and our government wants because they are dead set on weakening our currency in order to facilitate payment of our existing debt. What happens next if they fail to weaken our currency? Another way of asking the question is to say what if they cannot effectively increase the supply of money? That is simple, the depression gets worse and another impulse down takes place. That means more declines in house values, more unemployment, and more losses in the stock markets.

What if they succeed? Expect rallies in both commodities and the stock market as an increase in liquidity seeks risk and yield. Also, expect further price increases in essential things like food and energy resulting from the hot flow of money into these sectors. This is known as cost push inflation.

What will gold do in either scenario? Gold will respond higher on a strong dollar because it will attract a bid for those who are seeking safety in an asset that has no counter-party risk of default. Gold will respond higher if the dollar collapses through support and seeks new all time lows because it will attract bids from those who want to retain purchasing power of their stored capital. Gold will have to compete with the stock market in this regard and this scenario will likely provide a shallower trajectory than if a collapse in confidence occurs. It is for this reason I expect both the government and Fed to facilitate a continued weak dollar policy in order to shape perceptions through the bolstering of the stock market, while periodically allowing the stock market to crash in order to bolster the dollar and their bond bids. One step forward, two steps back in retreat.

So we continue to muddle along waiting for the next squadron of black swans to fly over. The Fed is trapped.

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