The guest commentary below was written by written by Daniel Lacalle. This piece does not necessarily reflect the opinions of Hedgeye. 

Dollar Strength and Global Currency Debasement - 09.13.2019 King Kong dollar cartoon

Why are market participants scared of a strong dollar? Because for years there was a massive carry trade against the US dollar, predicated on a bet that constantly printing currency and cutting rates would never create inflation.

The world got used to betting on one thing -massive money supply growth- and the opposite -weak inflation-. Cheap money became expensive, as I explained in my book, Escape from The Central Bank Trap.

The US dollar is not strong. The loss of purchasing power of the greenback is the largest of the past three decades. The US dollar is only “strong” in relative terms against other currencies that are collapsing in a global currency debasement that comes after years of monetary excess.

The pound is not collapsing because of a misguided prime minister’s tax plan, it is collapsing alongside the yen, which saw the Bank of Japan intervene to try to stop the depreciation as well, the euro, the Swedish krona, the Norwegian, Danish krone, or most currencies.

In the past year until the closing of this article the US dollar index (DXY) has risen 19% and reached a twenty-year high and the yen is down 23% against the US dollar: The euro has fallen 15%, the pound 17%, the emerging market currency index also fell 14% and even in China the PBOC had to intervene, like the Bank of Japan or the Bank of England, to control a massive depreciation against the US dollar.

Welcome to the vacuum effect of the US dollar that we mentioned months ago.

In periods of complacency, the world’s central banks play at being the Federal Reserve without having the world’s reserve currency or the legal security and financial balance of the United States.

Many massively increase money supply without paying attention to the global and local demand for their currency, and in addition, governments issue more U.S. dollar-denominated debt, hoping low rates will make the financing of huge deficits affordable.

Complacency builds and all asset classes see massive inflows and elevated valuations because money is cheap and abundant. A monster multi-trillion carry trade with many bets on the long side and one short: the US dollar.

All this, in turn, leads the global demand for U.S. dollars to increase, not because the Federal Reserve conducts a restrictive policy, but because the comparison with others shows the alternative fiat currencies are much worse.

This is the hangover from the great monetary binge of 2020, which saw an unprecedented increase in the balance sheet of central banks and global money supply soar to all-time highs.

Furthermore, a massive binge that directly targeted at government current spending. Now, the boomerang effect is vicious: High inflation, currency collapses as well as equities and bonds market crash.

You wanted “unconventional” responses to a crisis? You got the most conventional of them all: Printing and destroying the purchasing power of the currency.

Implemented for centuries with the same disastrous effects only to be dusted off by a new group of bureaucrats that promised that this time would be different.

“Spend now and deal with the consequences later” was often repeated by Keynesian consensus economists and now they shrug their shoulders and wonder why their “models did not work” as Lagarde and Krugman have said recently. Their models said that inflation would not appear after printing trillions of dollars and euros at the same time and none of them wondered if the models were junk.

Why did they not question their “models”? Because the models said what they wanted to hear. However, inflation did appear, it was not transitory, and the trap was set.

An overleveraged, massively indebted world with gigantic imbalances built on top of each other due to the placebo effect of monetary laughing gas generated the “bubble of everything” and now it bursts.

The US dollar is not strengthening because of a few, and modest rate hikes, the world’s currency and asset bubble is deflating.

As we said months ago, the U.S. dollar has created the conditions to be the most demanded currency simply because other central banks have been much more reckless. It only took an inflationary process that the central banks themselves denied or called transitory to raise the alarm of a market with overly optimistic expectations.

Liquidity is often taken for granted and what the world is living is the evidence that it is crucial in the market and the US dollar is the house with the largest number of windows and doors in a fire.

You may dislike it, get angry or reject it, but it is a fact. The US dollar has proven to be the king, even destroying cryptocurrencies’ valuations in the process, because it has proven that liquidity matters more than quality thesis views.

The implications of a global currency debasement process like this are enormous: Widespread wealth destruction, persistent inflation making citizens poorer, emerging market reserves evaporating, making their recovery more difficult, earnings expectations plummeting… and  all this coming from a Federal Reserve move that means that its balance sheet has barely reduced and rates are still low, even in negative territory if you see real inflationary pressures and not market participants’ assumptions of inflation expectations, which are always artificially low.

What about gold? Gold is down in US dollars but outperforming equities and bonds. However, gold is up in most global currencies.

The US dollar can lose its status as world reserve currency, but it is hardly feasible short term, because all contenders are implementing even more aggressive monetary excess policies. Think about Japan or the UK central bank trying to curb a yen or pound depreciation by printing even more money.

The next time you read from Keynesian consensus experts that massive stimulus plans are warranted because the models say there is no risk, remind them that they built the models to always show that government and monetary excess is inexistent ad therefore the models are rubbish.

The problem is that policymakers will not learn because they benefit from inflation and currency depreciation. It is a form of taxation and wealth transfer from the productive to the politically connected.

Many will blame the Federal Reserve for acting too quicky and aggressively, not for doing it too late and after too much. Most will demand more currency debasement and monetary excess. And the result will be the same.

US citizens are suffering the loss of purchasing power of their currency and the collapse of their investments while the rest of the worlds’ families and businesses see their real wages vanish and their currencies become worthless.

Cheap money is expensive. Always.


This is a Hedgeye Guest Contributor note by economist Daniel Lacalle. He previously worked at PIMCO and was a portfolio manager at Ecofin Global Oil & Gas Fund and Citadel. Lacalle is CIO of Tressis Gestion and author of Life In The Financial MarketsThe Energy World Is Flat and the most recent Escape from the Central Bank Trap. This piece does not necessarily reflect the opinions of Hedgeye.