When large ships first begin sinking, they tend to sink evenly. The lowest part of the hull, or bilge, fills with water increasing the weight of the ship and pulling the entire ship down evenly. Then as the water-level reaches successively higher decks, the rushing water often causes an increase in weight towards the bow or the stern. The increased weight of water on one end of the doomed ship causes the opposite end to rise dramatically out of the water. The boat seems to rise-up one long and final time — before it sinks into the depths below. Hence the expression: “Even a sinking ship comes up one last time.”
It’s a good analogy for the dollar.
Stability is an illusion. The overall down-trend is clear. But one must remember that counter-trends are typically far more powerful than many expect – and many counter-trends last far longer than expected as well.
The case for an epic rally in the USD
Let’s discuss the factors that could conceivably bring about the mother of all counter-rallies in the USD.
There are many theories regarding the Federal Reserve’s true intent regarding dollar strength, stability and even longevity — but what is clear to all is that the Fed is ultimately a political entity: They care deeply about their own perception, and they work tirelessly on perception management.
What is also clear about the Fed is that they are typically the last to recognize profound financial trends – and likewise they have a track-record for rather profound over-reaction when those times come.
In anthropomorphic terms, the Fed is short-sighted, slow and clumsy. It tends to lunge and lunge late.
Currently, there is growing alarm among both Beltway and financial insiders about the health of the US dollar and it’s perception abroad. With increasing frequency, the dollar’s reserve status is being overtly called into question.
While the standard reaction to such questions about the dollar’s health is to point out that ‘the dollar may be weak, but has plenty of life left’, we must point out that this reaction flies in the face of historical experience with other imperial declines:
History shows us that empires typically end slowly – and then quickly. In general, the process of imperial-decline typically begins slowly — giving rise to varying sets of new, disruptive forces operating outside of public consciousness. Those disruptive forces begin to grow slowly and then exponentially faster – ultimately rising to the fore very quickly and unexpectedly.
The rise of disruptive forces
We are seeing these disruptive forces clearly at work with the development of the BRICS bank, and the multitude of currency-swap deals which increasingly criss-cross the map with non-dollar trade pathways. But the BRICS bank is merely the latest manifestation of the many disruptive forces biting at the heels of US dominance.
Far away at the edges of the empire, ISIS seemingly rose out of nowhere to challenge US military might in ways that would have been unthinkable just a few years ago. In Europe, our old adversary Russia suddenly seized the “jewel of Ukraine” — and apparently the entire area east of the Dnieper — and the West managed to muster little more than a few sanctions which Putin promptly laughed at.
We are also seeing such disruptive forces in the surging popularity of BitCoin which lingered under the radar for years before exploding to the fore.
The popularity of mainstream media – the mouthpiece of any empire – has suddenly collapsed dramatically with bastions of market propaganda like CNBC entering what look like death-spirals of declining viewership. The hottest buzzwords in business-startups today are “disruptive media” and “disruptive technology” – indicating that the real room for new business-development is in areas formerly controlled by established players whose grip on dominance is now sliding.
We could go on, but suffice to say that on literally every level – financial, political, commercial, military and cultural — the status-quo is suddenly burning.
As we have long known, such disruptive forces (both domestically and globally) would one day amount to a threat to the dollar in earnest. At such time the threat to long-term dollar-hegemony would suddenly be brilliantly visible even to those not paying attention. The mainstream media, which has long avoided this subject, would suddenly take notice. Why? Because they would have to.
That day may well be here.
The BRICS bank
This week’s announcement about the formation of a BRICS bank is as clear a shot across the bow of dollar hegemony as we have yet seen. Not only is it being reported loudly by the mainstream media, it is being reported in the context of being an existential threat to dollar hegemony. This latter distinction is important. The potential mortality of the USD is now rising swiftly in public consciousness.
This brings us back to the Fed.
While the reality is that the dollar has quite likely passed its historic point of no return, that doesn’t mean the Fed won’t “lunge and lunge late” as they are so wont to do. As we all know, underlying the ongoing loss of the dollar’s strength are a host of structural problems that simply cannot be addressed by the Federal Reserve alone: No amount of monetary policy will bring back American manufacturing dominance. Nor will monetary policy undo decades of poor fiscal governance at the legislative level.
Nonetheless, a loss in dollar confidence is something that the Fed will and must react to despite the impossibility of their long term success.
The Federal Reserve may ultimately be forced to act — if for no other reason than to create a historical footnote against the claim that the dollar’s destruction was their own doing. But any attempt to save the dollar at this stage will not come cheaply or without economic casualties.
How this scenario plays out:
First: We must concede that prediction is a fool’s errand. We humbly admit to being fools when it comes to prophecy. What follows is our best guess:
Should the Fed tighten, a sudden rise in interest rates and a sudden scarcity of liquidity would have serious consequences for much of America’s and the world’s business and financial landscape. The Fed would stop injecting its $1 trillion in annual monetary-heroin into the economy causing immediate withdrawal symptoms. Equity markets would almost certainly collapse, as there are almost no market participants who believe indexes can maintain their current levels without Federal Reserve “support”.
On the other hand the dollar would soar.
With a soaring dollar, many emerging-market nations would begin to teeter. As happened during the 1997 Asian Currency Crisis, EM’s would bear brutal spikes in interest payments on their $7 trillion in foreign denominated debt. Foreign inflows would unwind and inflation would jump as EM currencies began to decline.
Shockwaves of emerging market instability would likely ripple into Europe. Europe’s already unstable banks would sound the alarm. “Whatever it takes” Draghi would be “forced” to unleash repeated waves of QE in an echo of the US’ post-crisis years.
Efforts to save Europe’s southern economies will likely prove futile . Their chronic high unemployment, lack of competitive industrial capacity and lack of monetary flexibility will create severe stresses in Euro-land. Italy’s debt at nearly 140% of GDP will either prove insurmountable or politically unfeasible within an increasingly fractured Europe. European unemployment would swiftly morph into unrest. Fukuyama’s “end of history” would begin to seem like a fairy tale. What happens to the structure of the EU is anyone’s guess but suffice to say that Europe’s problems are decidedly not over and a suddenly strong dollar would likely exacerbate them considerably.
Further east, Putin would likely seize the moment. His dreams of rebuilding Russia’s former glory will become a terrifying reality for those on Europe’s fringe.
Those US companies flush with cash would go on buying sprees around the world.
In the US, food and housing prices would be seen turning the corner as investors squatting on leveraged properties would be forced to disgorge them en masse. Food inflation would slow and reverse. Millennials would gradually become an economic force at last.
Still no more secure than they were prior to 2008, the US and global banking systems would be strained to the breaking point and bail-ins would likely become a deeply unpopular reality. Debate over “nationalizing banks vs. bailing them out” would once again be heated –with both sides accusing the other of abandoning the principles of capitalism.
Such consequences would also play strongly into the hands of the State, which would expand its reach dramatically and uncomfortably — in ways that would likely come under intense criticism and resistance.
For those who would say the powers-that-be would never do this, we remind them that there are indeed winners in this scenario and those winners are without question heavy-hitters on the American economic and political landscape. Or course, there will be losers too.
At this point in our strong dollar scenario, battle lines among America’s power groups will be increasingly well-defined, but likely not along the traditional lines of politics. That there will be losers will have become abundantly clear. Some of those losers will be among the nation’s most powerful.
Their calls for Federal Reserve action to “save” the economy will grow louder. Keynesian priests like Paul Krugman will preach the easy “virtues” of money printing, despite the fact that it was money printing that brought us to this extreme.
Which side wins? The fiscally responsible side or the money-printers?
Unfortunately we don’t think any extended era of Federal Reserve responsibility can last… although to be clear these are not short-term trends we are discussing. The Fed is too politicized and too prone to the belief that what feels good is good. Nor has the Fed ever demonstrated that it is a forward-thinking institution.
Our best guess is that ultimately it is those voices clamoring for monetary irresponsibility that prevail. Why? Because grimly: Politics trumps responsibility.
Many of the powers-that-be will opt for their soon-to-be-flooded first-class cabins over the indignity of the life-boat. The Fed will have saved face – and those with capital to spend will have increased their assets dramatically during this time. Like a doomed ship, the dollar will have risen one final time. It’s bow rising sharply in the water before resuming it’s descent.
Might this scenario play out very differently? Might it not happen at all? Emphatically, yes and yes.
We do believe the Fed will be forced to act. We believe such actions will ultimately be self terminating due to political and social forces. We believe that the effects will be violent and last far longer than many believe.