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Bigger Fish to Fry, and update to Moving Some Macroeconomic Deck Chairs: The Dollar, Dollar Swaps, Bonds and LIBOR

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May 17, 2010 – Comments (9)

This is an update to the original post that I wrote in the beginning of April: Moving Some Macroeconomic Deck Chairs: The Dollar, Dollar Swaps, Bonds and LIBOR

I am going to stick with my intro from last time because it sets the stage:

I am bearish on the US Dollar Long Term. This is no secret and I have been an outspoken critic of US monetary policy for a long time. Will we get a continued rally in the Dollar for the short term (next few months)? Yes, I think that is likely. But even a few months is short term in the bigger environment.

Here is an in-depth macro analysis of the Dollar that I wrote months ago: Thoughts on the US Dollar, Analysis of the USDX Long Term, Follow up on the Gold Blog. Aside from the fundamentals, I think the technicals also paint a bleak long term picture for the Dollar:


And we are getting the continued rally in the dollar like I was saying a month and a half ago. I am a long term dollar bear, but I am certainly not short it at the moment.

But you ask:

"What about deflation"
"What about inflation"
"What about hyper-inflation", etc.

If anybody is subscribing to an "either/or" philosophy here with regard to the monetary outcome, they don't know what they are talking about. It will be a combination.

There is NEVER anything in economics and especially macroeconomics that has only one cause and one effect. There are always multiple effects with varying degrees of influence (both in absolute value and transience). There will be deflationary impulses and there will be extreme monetary inflation, the Fed will see to that. Which means that I think the most likely outcome will be a combination of the two: stagflation. Economically correlated assets go down in value (like your home and equities as a general asset class) and things you need to buy/consume (such as real assets / commodities) cost more. Really the worst of all possible outcomes.  But before I start veering way off topic, I lay out the case for a simultaneous deflationary and inflationary (stagflation) outcome here: Debt Saturation - http://caps.fool.com/Blogs/ViewPost.aspx?bpid=357428

In addition, see the link at the top of the page for a dollar / equity correlation chart that disproves the blanket statement that "inflation / a weak dollar helps stocks go up".

Dollar Swaps

I spent a lot of time in my last post discussing Dollar Swaps and the role that they play in the deleveraging crisis of 2008-2009. Here was what I wrote last time:

But we also have a very steep drop in LIBOR during the deleveraging crisis. Why is that? If everybody, most especially financials are scared, because there is a deleveraging and liquidity crisis, why would LIBOR go down?

Because the Fed was pumping the system with Dollar Swaps!!

**If you want the real reason for the "bottom" in March 2009, there it is.**

All arguments for compelling valuations are BS, or "once in a lifetime buying opportunities" are BS. We stopped the freefall NOT because the market said "no mas", but because the Fed stuck an inflatable pool halfway underneath the cliff divers trajectory. It forced liquidity into the system as it was seizing up. If you really want to understand this issue, read Kristjan Velbri's excellent post Dollar Liquidity Swaps & The Financial Crisis.


And in the context of Bigger Fish, the Fed after sucking up all of the open Dollar Swaps from the last crisis just rolled out a fresh batch of brand spanking new Dollar Swaps: http://www.federalreserve.gov/newsevents/press/monetary/20100509a.htm

n response to the reemergence of strains in U.S. dollar short-term funding markets in Europe, the Bank of Canada, the Bank of England, the European Central Bank, the Federal Reserve, and the Swiss National Bank are announcing the reestablishment of temporary U.S. dollar liquidity swap facilities. These facilities are designed to help improve liquidity conditions in U.S. dollar funding markets and to prevent the spread of strains to other markets and financial centers. The Bank of Japan will be considering similar measures soon. Central banks will continue to work together closely as needed to address pressures in funding markets.

Basically the idea behind the Fed is to head the next crisis off at the pass. The last crisis was a deleveraging and liquidity crisis. And the Fed wants to make sure that the crisis in Europe does not get amplified by a lack of liquidity in the reserve currency. And I am not faulting the Fed for this move. It makes a lot of sense. In fact, if I were in charge of the Fed I would fire myself... errr, I mean I would probably do the same thing.

But before everybody gets all ga-ga bullish about guaranteed liquidity, lets consider the context. The Fed stuck an inflatable pool halfway underneath the cliff divers trajectory when it forced liquidity into the system as it was seizing up during the last go around. That was a reactive move that prompted to the market to bounce off its oversold conditions. This is a proactive move, that while can be addressed as an act of prudence, speaks more like an act of desperation. The Fed is trying to stave off debt contagion. And since this crisis is sparked by sovereign debt worries and the the US debt sustainability issue resembles Greece more than it does Germany, the Fed and the Treasury have a very real reason to be afraid.

While this development is not immediately bearish, it is certainly in no way bullish.

LIBOR

Here is the LIBOR / Dollar picture from my April 6 post. Read the notes carefully:



ENLARGE

And what does the picture look like today? Something very bearish. LIBOR is rising and accelerating. Fear is coming back en vogue. Contagion is the new 9-letter 4-letter word (...?!?!). A lot of people are saying "debt issues are overblown, buy the dip on the Euro". ... I am not so sure about that. Please see this EUR/USD analysis and projection that I put together back in March: Thoughts on the Euro, the Dollar, and a Long Term EUR/USD Count. The current EUR/USD is 1.23 which is about halfway down to my target from that post. So LIBOR, TED, the Dollar, Dollar Swaps, etc. are all saying it is time to be very cautious.



ENLARGE

9 Comments – Post Your Own

#1) On May 17, 2010 at 10:50 AM, outoffocus (23.17) wrote:

Good stuff.

But you ask:

"What about deflation"
"What about inflation"
"What about hyper-inflation", etc.

If anybody is subscribing to an "either/or" philosophy here with regard to the monetary outcome, they don't know what they are talking about. It will be a combination.

My boyfriend and I took an hour and watched that documentary Jgus put up yesterday.  That blog was perfect timing because Friday I came home and expressed my interest in buying physical silver. (If I, a person with very little in savings compared to most Fools, am considering buying physical metals, I must be worried about something.)  Afterwards we talked about hyperinflation and I explained to him that I believe we will have more of a "hyper-stagflationary" scenario (I assume this word doesn't currently exist but should be added to our vocabulary shortly); where assets and goods normally purchased with debt will deflate in value while commodities continue to go up.

This conversation is what sparked to question of who do I sell my precious metals to in the event I want to sell.  TBQH, I dont want to buy physical bullion until I get a solid answer for that. It is prudent to do proper due diligence with all investments.

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#2) On May 17, 2010 at 10:52 AM, outoffocus (23.17) wrote:

Maybe Sinchy can chime in since hes the subject matter expert.

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#3) On May 17, 2010 at 11:16 AM, binve (< 20) wrote:

outoffocus,

Thanks!

>>Afterwards we talked about hyperinflation and I explained to him that I believe we will have more of a "hyper-stagflationary" scenario (I assume this word doesn't currently exist but should be added to our vocabulary shortly);

Nice term fabrication! That is definitely a possiblility. I do think that most inflationist discount the amount of debt that is collapsing (even though most deflationists use measures like M2 and M3, which have a lot of non-monetary components to prove their point) while at the same time most deflationists discount the amount of monetary inflation the Fed can generate (they argue that the Fed creating base money is like pushing on a string because the banks don't have to lend, even though I am many others have pointed out that the Fed has gone around the banking system and has started monetizing private sector debt directly, which is a trend that is likely to increase not decrease). Most people on either side of the debate is not considering strong evidence that both forces are significant.

>>This conversation is what sparked to question of who do I sell my precious metals to in the event I want to sell.  TBQH, I dont want to buy physical bullion until I get a solid answer for that. It is prudent to do proper due diligence with all investments.

That is a good question, but I would argue that any asset bears that risk.

Can you sell a house easily in today's market?
What if there is a bank holiday and you don't have access to your checking account?
What if Forex counters are closed and you want to change your Dollars into Swiss Francs?
What if the market is closed and you need to exit out of a long position knowing that horrible news is coming out?

There are lots of ways where any assets might not be liquid either due to market events or government events.

So the question I ask myself is: In the event that I can't sell for a short period of time, is it likely that the fundamentals of my investement will get better or worse in a crisis and still retain value when I can sell? And the answer IMO for gold and silver is Yes.

Also, there are a lot more dealers that will exchange gold and silver than you would imagine. Bullion dealers obviously. But jewelers, pawn brokers, sometimes just straight bartering. And no official market needs to be open for those transactions to occur.

My $0.02. Thanks!..

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#4) On May 17, 2010 at 11:30 AM, binve (< 20) wrote:

outoffocus,

>>>>This conversation is what sparked to question of who do I sell my precious metals to in the event I want to sell.  TBQH, I dont want to buy physical bullion until I get a solid answer for that. It is prudent to do proper due diligence with all investments. ,

In re-reading this, are you asking about not being able to sell in a crisis, or just selling in general?..

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#5) On May 17, 2010 at 11:39 AM, outoffocus (23.17) wrote:

binve

I'm just talking about selling in general. Last thing I need is to invest my savings into something and not be able to sell. I know there are places like Ebay but what if I want cash in hand?

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#6) On May 17, 2010 at 11:45 AM, binve (< 20) wrote:

outoffocus ,

There are lots of places: NYMEX, Kitco, BullionVault, GoldMoney, ebay, (all of these are mail in bullion for an agreed upon spot at the time of the transaction. You just insure it and mail it in). Local bullion dealers (usually large spot premiums). If you are a big player then you could go straight to the COMEX, but for the small players like us, there are still lots of options. Thanks!..

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#7) On May 17, 2010 at 12:07 PM, XMFkmoney (99.67) wrote:

What's going on with the Y-axis of your chart?  Why didn't you use uniform spacing? 

For example, the distance of .5 between 4.75 and 4.25 is about 1/10th the size of the distance between .5 and .25, even though it should be larger.

The chart covers 0 to 5 but half the chart is between 1 and 0, which should only be 20% of the chart.   That means the LIBOR drops 50% on your chart in the blue box when it's really only moving 20%.  

Can you repost the chart with uniform spacing so we can see what's actually going on, please?

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#8) On May 17, 2010 at 12:13 PM, binve (< 20) wrote:

XMFkmoney,

>>What's going on with the Y-axis of your chart?  Why didn't you use uniform spacing?

It's a log scale chart. I have made this argument already: http://caps.fool.com/Blogs/ViewPost.aspx?bpid=290893

However this is a rate chart and not a price chart. So I can concede the "worth" of a linear chart in this instance. 

>>Can you repost the chart with uniform spacing so we can see what's actually going on, please?

Sure, I will do so in a minute...

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#9) On May 17, 2010 at 12:31 PM, binve (< 20) wrote:

XMFkmoney ,

Updated chart per your request:



ENLARGE..

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