Thursday, April 17, 2008

Debasing the dollar

This post is for all the bears out there (and I know there are a lot of you). Many of you are wondering if all of a sudden the collapse of the housing market is finished, if the banks are all of a sudden out of hot water, etc. I'll be the first to sound off with a resounding NO. No way in hell are we even close to being out of this mess. We had the largest real estate and credit bubble the world has ever seen. That doesn't get cleaned up in 6 months. No this will be a multi year process. It's been 8 years since the tech bubble burst. Thousands of companies have gone out of business and we still aren't even close to making new highs yet in the Nasdaq.

So far we haven't even seen one of the big home builders go out of business, although I suspect we will.

So far we've only seen one big bank go down (well it would of except the Fed bailed out BSC)

No this has several years yet to play out. It all depends on if the Fed let's the market do it's job and clean out the excesses or if they continue to try and prop things up as to how long this will last.

So if this still has years to go how come the market is rallying like it has already discounted the worst? I think it's for the same reason the last bear market ended. The Fed is again flooding the world with liquidity. Notice in 2001-03 how much the dollar declined. It took that kind of debasement of our currency to halt the bear market. It took a continued debasement to sustain the rally until 07. The reason it worked is because commodity prices at that time where just entering into a long term bull market and were still very depressed.

Now the Fed is applying the same cure to the present ills. However the environment is hardly the same as it was in 01. Commodity prices are now skyrocketing from 7 years of monetary inflation along with the problem of good ole supply and demand. So for the Fed to try and halt this bear in the same fashion as it did in 01 they will be throwing gasoline on the fire of commodity prices. Doesn't make sense does it but I think they are doing that very thing.

Look at the first chart of the dollar. Every time in the past that the dollar has gotten stretched 8-10% below the 200 DMA it has either bounced or traded sideways back to the 20 week moving average before resuming the primary downward trend. However now look at the last chart. After having gotten stretched almost 10% below the 200 DMA the dollar has now closed below the recent low without ever having come close to bouncing back up to the 20 WMA. If this continues and we see another leg down it will be unprecedented. It will also be a sign that Bernanke and co. have pulled out all the stops in an attempt to halt the bear market and have decided to sacrifice our currency to that end.

So while I think the fundamentals for the bear market are hardly over I also think the Fed is going to print however many dollars it takes to keep this market levitated for as long as possible.

How long this continues is just a matter of how long the economy can hold together with inflation spiralling out of control.