At the end of my last post, i made the assertion that all markets are inter-related and in particular that all markets take their cue from the dollar AND US treasury interest rates…. Since that is the theory we’re going with lets take a look at where i believe interest rates and the dollar are headed; from there we can look at other asset classes and make a prognostication on where they will head as well…..

Interest Rates, Currencies & a Fiat Currency World

All markets essentially either mirror or inverse the dollar, but the relationship between the value of the dollar and US interest rates is a bit more complicated… Usually, if a country has a weak currency its interest rates are high in order to compensate holders of the currency and debt denominated in that currency the risk of sovereign default, inflation, devaluation, etc… Its a supply and demand thing, if there is no demand for your debt/currency, rates will continue to climb up until they begin to to entice someone somewhere to hold your currency/debt through the risks presented above… BUT, the US is the issuer of the worlds reserve currency that affords us a “safety demand” component as well. So, every time the markets hiccup investors/algorithms pile into dollar assets….

In a fiat currency regime/world the money flow is like pushing on a water bed. If you push down somewhere another spot on the bed rises; ie. if the Euro falls the dollar usually rises and vice versa. Why? Bc, all the current ways of measuring value of these currencies is by basketing them against each other. For instance the $DXY dollar index measures its price/value by comparing/looking at the values of the Euro, and a host of other fiat currencies…

This setup gives the ** illusion of a “strong” currency vs a “weak” currency**, when in reality they are all losing value; just at different rates. Again, you may ask why? Well, think of it this way, if your currency strengthens against the dollar; your countries exports to the US drop, so you either lose those exports or your central bank prints some more currency in order to weaken its currency against the dollar; thus bringing the dollar back up and your currency back down… On and on it goes…

Its similar to boats in water, the water level rises but all boats essentially stay level (of course aside from the ones that capsize or spring a leak: (think debt default)…..

The interesting thing, is that even with this arrangement the US dollar is still losing alot of value fairly quickly… Lets take a look at a medium/long term dollar chart.

https://ipfs.pics/QmNzNtK96djKhv1K3xa5aE3RpAfUajXvAMW2fxtU7nCEtx

This is NOT a strong chart… As a matter of FACT the dollar has lost about 50% of its value since 2001. **This chart shows a clear downtrend and in technical trading terms; this type of chart almost begs for all rallies to be SOLD not bought…. ** To be even more blunt this formation portends a drop to approximately 40-50 on this index for the dollar once the low is breached.

For posterity’s sake lets once again look at the long term interest rate chart that we looked at earlier to see how it fits/correlates with the dollar chart…

https://ipfs.pics/QmUT5uCpyCiouPLHXQqAzkpXy81GUZ2b3CZk3MQPJLBPQs

Lets recap what we have here….

A falling currency and a yield chart that is pretty close to breaching a very significant 30 year trend-line…. Now, remember what we stated above; interest rates usually rise to compensate holders of the currency/debt for the risks of inflation, devaluation, sovereign risk, etc…..

Even if we claim that interest rates can stay below that trendline; we should still ask ourselves; given the amount of debt the US now carries, does it make sense for rates to stay so low? I would contend that’s a no! That’s similar to you, personally racking up credit card debt and having your CC provider lower your rates…. It simply doesn’t happen! Of course, here we are dealing with a sovereign nation and the issuer of the world’s reserve currency. But, this only suspends reality for a short amount of time (yrs, in the time frame of nations), but it doesnt nullify it….

The 80′s, High Interest Rates & Dollar Comeback

Now im sure some of the more astute folks reading this might scream out and say “Hey, wait a second! The US went through high interest rates during the 80′s and the good times came back!” The US did go through a period of high interest rates, the 80′s. Paul Volcker sacrificed the economy (in the short term) to save the dollar. The dollar came back and the US economy revived and for 30 years was THE engine of the worlds consumption……

True

But, we arent in the 80′s and the US financial/political situation today is not what it was in the 80′s in several significant ways…

• The US was a creditor nation at that time. This is not the case today, as a matter of fact we are the biggest debtor in the world and possibly the biggest debtor nation to exist to date… Creditors usually have leeway in dealing with issues bc they have access to their own cash and savings. A debtor is ALWAYS at the mercy of his/her creditors. The US does have the ability to print its own currency, so we are not dealing with a “hard” money issue that Europe is facing now, but printing has ...its own problems as well. Mainly, loss of value/faith in the currency and higher interest rates.

• The US was the premier nation politically and industrially; China and Russia(formerly USSR) were for all intent and purposes either industrial back waters or financially weak; that’s not the case today… China, Russia and all of the developing nations are in stronger positions today. Investors and entrepreneurs have other options…

• The high rates of the 80′s were engineered by the Federal reserve to save the US dollar during double digit inflation. I HIGHLY DOUBT that will happen again! Why? First off, bc the FED right now is doing EVERYTHING it can to keep interest rates low… Second, bc the federal govt owes the rest of the world a HUGE amount of money…. The US govt would be instantaneously exposed to the ..world as bankrupt!

Which is why i believe this will be a Greece style event, a MARKET event not a FED engineered event.

Debt Dynamics & Interest Rates

It should be pretty obvious by now that this entire line of reasoning (part 1 and future parts) hinges on interest rates rising. Since we are at the lowest levels in 30-50 years and the US is the largest debtor with an ever increasing deficit; i think that is a pretty safe long term bet… Debt dynamics are pretty easy to forecast for a sovereign nation; you really only have two choices

1) Inflate

OR

2) Default

Either way, interest rates will rise! If the govt defaults on its debt (i doubt it will be a full default, we know how to use a printing press), the market will impose some punishing interest rates on US debt due to the increased risk. If the US inflates (which is what i believe they will do), again the market will impose those same rates…. Either way, the US will renege on its promises through inflation or default, or a combination of both…

Historically, govts that have access to a printing press and are not constrained by a gold standard always inflate until collapse occurs. It is the nature of govt to continue pushing the problem out until they have no other choice or until the next batch of suckers are in office.

Hopefully, this is starting to click….

Takeaway?

Why would you want to hold the currency (in the long term) or debt of the MOST indebted country on the planet? You don’t! There is NO good outcome….. You don’t want to be holding many dollars or long term treasuries. Especially since we are at the lowest rates in 30-50 years… Holders of treasuries are going to get slaughtered as interest rates rise, not only will they lose principal value on the treasuries they will also lose on the value/purchasing power those remaining dollars represent…..

In Part 1, i mentioned that there was a follow-on bubble (after the stock and real-estate bubble) that was still going to burst. I believe that bubble is the US treasury/dollar/reserve currency bubble. Markets will remain apathetic until they aren’t….

For more on this dynamic i can recommend “This Time is Different: Eight Centuries of Financial Folly".

As the Austrian economist von Mises said: “There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion or later as a final and total catastrophe of the currency involved.”

So, we’ve thought through the possibilities/scenarios and decided that the worst place to be is treasuries and US dollars… Since we stated earlier that almost everything else is tied to interest rates & the dollar how does this impact other asset classes like real-estate, commodities and precious metals?

Note: While the conclusion is dollar value loss and interest rate increase, that doesnt mean that there cant be short lived rallies in the dollar or short term lower interest rates… Markets dont move up or down in a straight line, there are always counter trend bounces, but when looking at long term the fundamentals always trump the technicals of trading that go on in that market.