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Thursday, December 09, 2004

Bottom for the dollar or dead cat bounce?

There is an old joke in the financial markets "Even a dead cat will bounce if you throw it down from a high enough building."

This refers to a "technical" or "oversold" rebound that sometimes occurs when a financial instrument (stock, bond, commodity, currency, etc) takes off for the cellar. The big money has been short the dollar for some time. Warren Buffet publicly stated two years ago that he was short the dollar, and the big funds have been, as well.

Why is the "price" of the dollar important? Because the value assigned to a nation's currency by the international market is the surest sign of the health of that nation's economy. It is like a "vote of confidence" in the nation itself by the international community.

Despite those who would talk up a cheap dollar as good for experts, devaluation of a nation's currency is a bad thing. Ultimately it is ruinous to a nation. We in the US can "get away with it" on a temporary basis because of our tremendous economic strength relative to the rest of the world. That picture is changing, and changing rapidly. Our very success has led to such a dramatic differential in international production costs, and the ease of moving data of all sorts over the internet puts other nations in the position of being able to compete with us. The European Union has a larger Gross Domestic Product than the USA, and both China and India will continue to make inroads in the world economy due to their vast supply of cheap labor (both technical and "blue collar").

It has only been since October or so that the euro's rise has turned to rout. This kind of radical move usually signals a "blow off," or the end of a price move. By the time it makes the newspapers everyone who is someone has already bought/sold the instrument. Now the only people entering the markets are the speculative dentists in Albany GA, and they don't have the staying power (translated: capital) to push it any lower, they are just late to the party looking for a "sure bet." When I used to trade "in the pits" I looked for "retail" sales coming in, from the brokers for Merril Lynch, Shearson, etc. That was a signal that the public was becoming aware, and usually a signal that the move was about over, at least temporarily. When the market turns against them, as it did with the dollar over the past two days, they have to get out, and get out NOW, at any price. That is what caused the following tumble in the euro against the dollar.

45 min euro chart

So, is this a "dead cat" in a long slide against the world's currencies? I think not. It is true that the Republican congress is guilty of fiscal recklesness that makes "spending like a drunken sailor" an insult to drunken sailors. However, the positive signs for the dollar are strong. Here are some:

1) There is a large interest rate differential between the dollar and the rest of the world's currencies.
2) Our productivity is continuing to grow.
3) Oil prices have peaked (or so it seems). We actually have excess capacity in reserves, and OPEC is talking about a "floor" for prices. That is GOOD.
4) Republicans may not have been able to restrain spending , but they can cut taxes, which is GOOD for both business and the populace....., in that the growth caused by tax cuts causes revenue to both the public and private sector.
5) Last but not least, we are a FREE society, with the closest thing to free markets that the world knows. Ultimately, that is a powerful trump card, as markets respond and adapt better than bureaucratic planners ever can.


Bloomberg this a.m.has reason 6 to append to those above. When governments start noticing that currency rates are hurting their economies, they start trying to make moves to change policies that affect those exchange rates.

The most obvious one is to step into the market itself to buy or sell euros/dollars/yen/francs or whatever. Although this won't stop a long term trend, it will often cause sharp and violent corrections, as a nation's treasury suddenly unloading a billion dollars worth of euronotes is a big bite for the interbank market. Traders who have been happily piling on to a clear trend get nervous.

The second and more serious step is changing interest rates. That is more complicated in Europe, with all the interconnected nations and the central bureaucracy in Brussels. However, if the exchange rate continues to cause problems within the EC, look for them to take serious steps to halt the dollar slide.

1 comment:

M. Espinola said...

What you stated is 100% correct.

"..devaluation of a nation's currency is a bad thing. Ultimately it is ruinous to a nation. We in the US can "get away with it" on a temporary basis.."

The USD should rise against the Euro, as long as our over-inflated housing market does not burst due to too many sellers and not enough buyers, as oil related inflation continues to rise.