In These New Times

A new paradigm for a post-imperial world

Don’t Bet On the Dollar’s Rally Lasting Much Longer

Posted by smeddum on October 21, 2008

Don’t Bet On the Dollar’s Rally Lasting Much Longer
By: Graham Summers Tuesday, October 21, 2008 8:59 AM istockanalyst

This dollar rally is just about done.

As I’m sure you’re aware, starting in July, the dollar began its biggest rally in years. Seeing this, the talking heads got jiggy and started proclaiming that the currency had entered a bull market.

As usual, they were horribly wrong.

The dollar is not in a bull market. It is in a massive short-covering rally, much like the one stocks experienced back in July when the SEC threatened to make short-selling illegal for financial stocks.

I’ll explain…
It is common corporate practice for international companies to borrow heavily in a currency that is depreciating relative to their domestic currency. On the surface, this practice appears to be fairly clever, since your debt is continually falling in value relative to your earnings. Thus, paying the debt off is much easier.

For the last six years, the primary depreciating currency to borrow in was dollars. It’s not difficult to see why. You could have borrowed in dollars at virtually any point during that time and had the old “disappearing debt” trick work like a charm.

However, when Russia invaded Georgia, the euro got a slap in the face. Already well overextended in its rally against the dollar, this triggered the “sell euros/ buy dollars” signal for institutional trading models around the world. As hedgies and their ilk piled in, the euro fell as the dollar had a substantial pop.

This in turn triggered a massive dollar short-covering rally from corporations that had borrowed in the currency. As more and more corporations covered their dollar shorts (i.e. bought dollars), the currency rose even higher. BNP’s Hans-Guenter Redeker estimates that there may have been as much as $10 trillion in dollar shorts worldwide.

Again, this rally has nothing to do with any improvement in the dollar’s fundamentals. In fact, if anything the dollar’s fundamentals have worsened considerably since this rally began.

Leaving aside the various bailouts/ interventions (Fannie/ Freddie/ AIG), the Feds are now running the printing presses like maniacs. The Adjusted Monetary Base has soared from $873B on Sept. 10 to $1.017 trillion as of the Wednesday before last. The compound annual rate of growth since August 13 is 114 %. It’s not yet Weimar Germany inflation… but it is approaching Argentinean levels.

At some point, the Fed’s inflationary tactics will begin to take hold of the financial markets. When this happens, the dollar rally will reverse. Now I can’t tell you exactly when this will happen, but I expect it will occur before the year-end. Smart traders should prepare in advance by having a few “anti-dollar” trades lined up to pull the trigger on when this happens.

I’ll detail some of them in my next essay…

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