By
May 12, 2002
Ok, repeat after me: The bear market ain’t over until:
Last week we discussed the CRB; this week we take on the dollar.
The US dollar has been in a monster, bear market rally since the early 1990s – going from strength to strength. This strength in the dollar is partially a reflection of the US’ amazing status as the lone military superpower and as the major economic superpower. Money wants to come here because it is relatively safe and because US markets have generally been bullish during the decade of the ‘90s. Foreigners have had the best of both worlds: they have been able to invest in stocks and see their stocks go up, while also having the dollar appreciate in terms of their home currency.
Since, at any given moment, money flows must balance, with all of this money coming into the US, there must be money going out, and indeed there is. The US is hemorrhaging money in its balance of payments, that is, we are buying things from overseas and paying for those cars and TVs and other items with dollars. The other thing that foreign money has been doing is buying bonds and stocks and propping up our markets, funding our debt, and keeping interest rates lower than they would otherwise be.
In one sense, this is not a bad thing. If you can get an automobile in trade for some paper, you are probably ahead of the game. All of this, however, depends on the willingness of foreigners to take and hold that paper (dollars).
On the other hand, if foreigners start selling dollars, markets will lose some of their support, interest rates will rise, and foreign goods will become more expensive, exacerbating inflation. If our markets are to be funded internally, our savings rate as a nation will have to go up, taking money out of the consumer society and deepening any recession, while hampering any recovery.
In summary, all the reinforcing goodness of the ‘90s could reverse and turn into reinforcing badness in the ‘00s.
My favorite magazine, The Economist, recently had a couple of articles, from which I would like to quote. The first is subtitled, "America’s huge external deficit is an accident waiting to happen." It goes on to say:
"The International Monetary Fund says that America’s current-account deficit poses one of the biggest risks to the world economy. … big current-account deficits are not necessarily bad, but … If capital inflows were to dry up, the current-account deficit would have to shrink, either through a slump in domestic demand or a fall in the dollar, or both."
The Economist also publishes the Big Mac index to try to determine the value of various currencies. This is a quasi-serious evaluation of the cost of a standardized basket of commodities in various currencies. The conclusion of the exercise in 2002 is, "In the history of the Big Mac index, the dollar has never been more overvalued."
What you are seeing in the news, now, is that Congress is being asked by US manufacturers to instruct the government to let the dollar decline. In a recession people look for whatever they can get to make the bad times better. They need to be careful what they ask for. Once the dollar starts down, our manufacturers may benefit, but the larger impact on consumers and on financial markets will create significant problems for the economy.
The dollar appears to be fundamentally overvalued and that is showing up on the political front.
How low can we go? At least a little lower than the low in the early ‘90s, and probably much lower. So if recent highs are as high as the dollar gets (which I do not think is the case), a 35% devaluation gets us to the 1992 lows. That’s huge.
Timing? I don’t know. The dollar has a 3-year cycle which next bottoms in 2004. That seems too quick. On the other hand, look at the rapidity of the decline of the dollar in the late ‘80s – from above current levels to beginning to make a bottom in just two years. So, let’s put 2004 on the list of targets, because it will square well with dates in later commentaries.
This just looks like a classic wave 4 triangle that is either completed or just about to be completed. If that is true, look for a thrust up to new highs in 5 waves, and then that will be all she wrote.
If this is not a triangle, then the bear market has likely already reasserted itself and is under way. The way we will tell is that for the bull to remain intact, the "Critical value" at c must not be violated.
Any hope for continuance of the bull market in stocks is dependent on continued bullishness in the dollar, because that bullishness, to some extent, measures the willingness of foreigners to participate in our markets. There could well be another run up in stocks corresponding to the new high in the dollar, but that is the topic of an analysis due in a couple of weeks.
Copyright Ó Kit Webster 2002