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Why The Bottom Fell Out Of The Dollar, And What You Should Expect Next
It’s All About The Fed … and The Data?
When it comes to the Fed and the dollar it’s all about the data. The committee has said time and time again through one Chairman after another that it is data dependent. It was just the other day I was saying in a post on this website that the FOMC is not know to be preemptive or to front-run events. If the data doesn’t support a policy change there is no policy change and the data doesn’t support a policy change, at least not yet.
That is why I was among the most surprised when the FOMC raised rates in a surprise move earlier this week. The committee cut rates by 50 basis points, effectively two cuts in one, and they may not be through. If history is to repeat itself as it has so many time in the past, now that the committee has made one emergency rate cut it is likely to cut again and maybe as soon as the meeting in two weeks.
The result of the cut has been widespread. The dollar fell against the basket of world currencies sending the DXY deeper into reversal. Now trading at a one-year low the index is in danger of falling below key-support. Key support is at the $95.50 level, a break of which could send the dollar crashing. The risk for traders is the virus. The rate-cut and dollar decline are driven by the virus and nothing else, once the sickness passes these moves are likely to end.
Likewise the data. Today’s non-farm payrolls report gives no indication of economic weakness or the need for a rate cut. Ironically, the reason for the rate cut is to ensure this situation doesn’t change. The headline NFP came in 100K above consensus at 277,000 and upward revisions to the tune of 85,000. The unemployment ticked lower even as the number of workers in the workforce increased. Wages, the best gauge of economic health, rose 0.3% for the month and are up 3.0% YOY.
Gold Is Getting A Boost, New All Time Highs Are In Sight
Gold prices are among the only to be moving higher, other than bonds that is. The spot price of gold is struggling with resistance in today’s action but the bias is bullish. Weakening dollar values and the flight-to-safety trade are only part of the picture. The underlying fundamentals of gold were bullish before the FOMC rate cut, not those fundamentals are super-charged. If the FOMC cuts rates again in two weeks, or even just indicates dovishness, gold prices could surge again. Resistance is currently at the $1,675 level, a break above that would bullish. If not we may be dealing with a double-top.
US Dollar Value Measured Three Different Ways
Where Is the Dollar’s Value Headed Next?
Image by Catherine Song. © The Balance 2020
The value of the U.S. dollar is measured in three ways: exchange rates, Treasury notes, and foreign exchange reserves. The most common method is through exchange rates. You should be familiar with all three in order to understand where the dollar is headed next.
The dollar exchange rate compares its value to the currencies of other countries. It allows you to determine how much of a particular currency you can exchange for a dollar. The most popular exchange rate measurement is the U.S. Dollar Index.
These rates change every day because currencies are traded on the foreign exchange market. A currency’s forex value depends on many factors. These include central bank interest rates, the country’s debt levels, and the strength of its economy. When they are strong, so is the value of the currency. The Federal Reserve has many monetary tools that can influence the strength of the dollar. These tools are how the government can regulate exchange rates, albeit indirectly.
Most countries allow forex trading to determine the value of their currencies. They have a flexible exchange rate. The U.S. dollar rate shows the value of the dollar in comparison to the rupee, yen, Canadian dollar, and the pound.
Below, you can track the dollar’s value as measured by the euro since 2002.
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This chronology explains why the dollar’s value changed.
2002-2007: The dollar fell by 40% as the U.S. debt grew by 60%. In 2002, a euro was worth $0.87 versus $1.44 in December 2007.
2008: The dollar strengthened by 22% as businesses hoarded dollars during the global financial crisis. By the year’s end, the euro was worth $1.39.
2009: The dollar fell by 20% thanks to debt fears. By December, the euro was worth $1.43.
2020: The Greek debt crisis strengthened the dollar. By the year’s end, the euro was only worth $1.32.
2020: The dollar’s value against the euro fell by 10%. It later regained ground. As of December 30, 2020, the euro was worth $1.30.
2020: By the end of 2020, the euro was worth $1.32 as the dollar had weakened.
2020: The dollar lost value against the euro, as it appeared at first that the European Union was, at last, solving the eurozone crisis. By December, it was worth $1.38.
2020: The euro to dollar exchange rate fell to $1.21 thanks to investors fleeing the euro.
2020: The euro to dollar exchange rate fell to a low of $1.05 in March, before rising to $1.13 in May. It fell to $1.05 after the Paris attacks in November, before ending the year at $1.08.
2020: The euro rose to $1.13 on February 11 as the Dow fell into a stock market correction. It fell further to $1.11 on June 25. This happened the day after the United Kingdom voted to leave the European Union. Traders thought uncertainty surrounding the vote would weaken the European economy. Later on, the markets calmed down after realizing that Brexit would take years. It allowed the euro to rise to $1.13 in August. Not long after, the euro fell to its 2020 low of $1.04 on December 20, 2020.
2020: By May, the euro had risen to $1.09. Investors left the dollar for the euro due to allegations of connections between President Trump’s administration and Russia. By the end of the year, the euro had risen to $1.20.
2020: The euro continued its ascent. On February 15, it was $1.25. In April, the euro began weakening after President Trump initiated a trade war. The euro fell to $1.16 on June 28, a few days after the Federal Reserve raised the fed funds rate to 2%. A higher interest rate strengthens a currency because investors receive more return on their holdings. But the by end of the year, the euro was $1.15.
2020: The euro declined until May 29 when it reached $1.11. It rose briefly in June to $1.14, fell to $1.11 in July, then rose to $1.12 in August. The euro followed news about the ongoing trade war.
The dollar’s value is in sync with the demand for Treasury notes. The U.S. Department of the Treasury sells notes for a fixed interest rate and face value. Investors bid at a Treasury auction for more or less than the face value and can resell them on a secondary market. High demand means investors pay more than face value and accept a lower yield. Low demand means investors pay less than face value and receive a higher yield. A high yield means low dollar demand until the yield goes high enough to trigger renewed dollar demand.
Before April 2008, the yield on the benchmark 10-year Treasury note stayed in a range of 3.91% to 4.23%. That indicated stable dollar demand as a world currency.
2008: The 10-year Treasury note yield dropped from 3.57% to 2.93% between April 2008 and March 2009 as the dollar rose. Remember, a falling yield means a rising demand for Treasurys and dollars.
2009: The dollar fell as the yield rose from 2.15% to 3.28%.
2020: From January 1 to October 10, the dollar strengthened, as the yield fell from 3.85% to 2.41%. It then weakened due to inflation fears from the Fed’s quantitative easing 2 strategy.
2020: The dollar weakened in early spring but rebounded by the end of the year. The 10-year Treasury note yield was 3.36% in January. It rose to 3.75% in February then plummeted to 1.89% by December 30.
2020: The dollar strengthened significantly, as the yield fell in June to 1.443%. It was a 200-year low. The dollar weakened toward the end of the year, as the yield rose to 1.78%.
2020: The dollar weakened slightly, as the yield on the 10-year Treasury rose from 1.86% in January to 3.04% by December 31.
2020: The dollar strengthened through the year, as the yield on 10-year Treasury fell from 3% in January to 2.17% by year-end.
2020: The dollar strengthened in January, as the 10-year Treasury yield fell from 2.12% in January to 1.68% in February. The dollar weakened as the yield rose to 2.28% in May. It ended the year at 2.24%.
2020: The dollar strengthened as the yield fell to 1.37% on July 8, 2020. The dollar weakened as the yield rose to 2.45% at year-end.
2020: The dollar weakened as the yield hit a peak of 2.62% on March 13. The dollar grew stronger as the yield fell to 2.05% on September 7. The yield rose to 2.49 on December 20, ending the year at 2.40.
2020: The dollar continued weakening. By February 15, the yield on the 10-year note was 2.9%. Investors were worried about the return of inflation. The yield remained in this range, rising to 3.09% on May 16 then falling to 2.69% by December.
2020: The dollar weakened as the 10-year yield peaked at 2.79% on January 18. But on March 22, 2020, the yield curve inverted. The 10-year yield fell 2.44%, below the three-month yield of 2.46%. That meant investors were more worried about the U.S. economy in three months than in 10 years. When investors demand more return in the short term than in the long run, they think the economy is headed for a recession. The yield curve recovered, then inverted again in May. On August 12 the 10-year yield hit a three-year low of 1.65%. That was below the 1-year note yield of 1.75%. Although the dollar was strengthening, it was due to a flight to safety as investors rushed to Treasuries.
Foreign Currency Reserves
The dollar is held by foreign governments in their currency reserves. They wind up stockpiling dollars as they export more than they import. They receive dollars in payment. Many of these countries find that it’s in their best interest to hold on to dollars because it keeps their currency values lower. Some of the largest holders of U.S. dollars are Japan and China.
As the dollar declines, the value of their reserves also decreases. As a result, they are less willing to hold dollars in reserve. They diversify into other currencies, such as the euro, yen, or even the Chinese yuan. This reduces the demand for the dollar. It puts further downward pressure on its value.
As of the first quarter of 2020, foreign governments held $6.7 trillion in U.S. dollar reserves. That’s 61% of the total allocated reserves of $10.9 trillion. It’s down from a height of 66% held in 2020. It’s even less than the 63% held in 2008.
At the same time, the percentage of euros held in reserves was 20% in 2020. That’s less than the 27% held in 2008. All other currencies gained ground as banks diversified their foreign exchange holdings. The International Monetary Fund reports this quarterly in its COFER Table.
How the Value of the Dollar Affects the U.S. Economy
When the dollar strengthens, it makes American-made goods more expensive and less competitive compared to foreign-produced goods. This reduces U.S. exports and slows economic growth. It also leads to lower oil prices, as oil is transacted in dollars. Whenever the dollar strengthens, oil-producing countries can relax the price of oil because the profit margins in their local currency aren’t affected.
For example, the dollar is worth 3.75 Saudi riyals. Let’s say a barrel of oil is worth $100, which makes it worth 375 Saudi riyals. If the dollar strengthens by 20% against the euro, the value of the riyal, which is fixed to the dollar, has also risen by 20% against the euro. To purchase French pastries, the Saudis can now pay less than they did before the dollar became stronger. That’s why the Saudis didn’t need to limit supply as oil prices fell to $30 a barrel in 2020. The value of money affects you daily by how much commodities you can purchase with your funds at a given time. When prices for food or gas rise, your money’s value shrinks because a given amount can now buy less than what it used to.
The Value of the Dollar Over Time
The dollar’s value can also be compared to what could have been bought in the United States in the past. Today’s dollar value is much less than that of the past because of inflation.
The growing U.S. debt weighs on the back of the minds of foreign investors. In the long-term, they may continue to, little by little, move out of dollar-denominated investments. It will happen at a slow pace so that they don’t diminish the value of their existing holdings. The best protection for an individual investor is a well-diversified portfolio that includes foreign mutual funds.
Dollar Value Trends from 2002 to July 2020
From 2002 to 2020, the dollar declined. This was true with all three measures. One, investors were concerned about the growth of the U.S. debt. Foreign holders of this debt are always uneasy that the Federal Reserve would allow the dollar’s value to decline so that U.S. debt repayments would be worth less in their own currency. The Fed’s quantitative easing program monetized the debt, thereby allowing an artificial strengthening of the dollar. This was done to keep interest rates low. Once the program ended, investors grew concerned that the dollar could weaken. Two, the debt put pressure on the president and Congress to either raise taxes or slow down spending. This concern led to sequestration. It restricted spending and dampened economic growth. Investors were sent to chase higher returns in other countries.
Three, foreign investors prefer to diversify their portfolios with non-dollar denominated assets.
Between 2020 and 2020 the dollar strengthened. There were six reasons the dollar became so strong:
- Investors worried about the Greek debt crisis. It weakened demand for the euro, the world’s second choice for a global currency.
- The European Union struggled to boost economic growth through quantitative easing.
- In 2020, economic reform slowed China’s growth. It pushed investors back into the U.S. dollar.
- The dollar is a haven during any global crisis. Investors bought U.S. Treasurys to avoid risk as the world recovered unevenly from the 2008 financial crisis and recession.
- Despite reforms, both China and Japan continued to purchase dollars to control the value of their currencies. It helped them boost exports by making them cheaper.
- The Federal Reserve signaled that it would raise the fed funds rate. It did so in 2020. Forex traders took advantage of the higher rates as Europe’s interest rates declined.
Between 2020 and 2020, the dollar weakened again. In 2020, it strengthened as investors sought safety. They are growing ever-more concerned about the impact of the Trump administration’s trade war.
U.S. Dollar Will Collapse When This Upcoming Event Happens (+74K Views)
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…If we want to better understand the answer to the elusive question of “When will the fiat US dollar collapse?”, we have to watch the petrodollar system and the factors affecting it….This is critically important, because once the dollar loses this coveted status…the destruction of the dollar is going to wipe out the wealth of a lot people, and that will cause political and social consequences that will likely be worse than the financial consequences. @A Financial Site For Sore Eyes & Inquisitive Minds
Prepared by Lorimer Wilson , editor of munKNEE.com – Your KEY To Making Money! [ This article of edited excerpts * from the original article by Nick Giambruno provides you with a 21% FASTER – and EASIER – read .]
The three points to understand here are:
- You absolutely must be internationalized before the U.S. dollar loses its status as the premier reserve currency. Internationalization is your ultimate insurance policy.
- The U.S. dollar’s status as the premier reserve currency is tied to the petrodollar system.
- The sustainability of the petrodollar system is linked to Middle East geopolitics…. @Economic Developments
The Rise & Fall of Bretton Woods
Being victorious in WWII and possessing the overwhelmingly largest gold reserves in the world (around 20,000 tonnes) allowed the U.S. to reconstruct the global monetary system with the dollar at its center in what was known as the Bretton Woods international monetary system. Simply put, the Bretton Woods system was an arrangement whereby a country’s currency was tied to the U.S. dollar through a fixed exchange rate, and the U.S. dollar itself was tied to gold at a fixed exchange rate. Countries accumulated dollars in their reserves to engage in international trade or to exchange them with the U.S. government at the official rate for gold ($35 an ounce).
By the late 1960s, exuberant spending from welfare and warfare, combined with the Federal Reserve monetizing the deficits, drastically increased the number of dollars in circulation in relation to the gold backing it and, naturally, this caused countries to accelerate their exchange of dollars for gold at the official price. The result was a serious drain in the U.S. gold supply (20,000 tonnes at the end of WWII to around 8,100 tonnes in 1971, a figure supposedly held constant to this day) so, on August 15, 1971, Nixon officially ended convertibility of the dollar for gold to halt the gold outflow. The U.S. defaulting on its promise to back the dollar with gold ended the Bretton Woods system.
The central justification that the gold–backed dollar had provided as to why countries held the dollar in their reserves and used it as a medium of international trade was now gone. With the dollar no longer convertible into gold, demand for dollars by foreign nations was sure to fall and with it, its purchasing power.
The Advent of the Petrodollar
OPEC passed numerous resolutions after the end of Bretton Woods, stating the need to retain the real value of its earnings (including discussions about accepting gold for oil), which resulted in the cartel significantly increasing the nominal dollar price of oil in the wake of August 15, 1971.
If the dollar was to sustain its status as the world’s reserve currency, a new arrangement would have to be constructed to give foreign countries a compelling reason to hold and use dollars and Nixon and Kissinger succeeded in retaining the dollar’s premier status by bridging the gap between the failed Bretton Woods system and the emerging petrodollar system.
Between the years of 1972 to 1974 the U.S. government completed a series of agreements with Saudi Arabia to create the petrodollar system. Saudi Arabia was chosen because of its vast petroleum reserves, its dominant influence in OPEC, and the (correct) perception that the Saudi royal family was corruptible.
In essence, the petrodollar system was an agreement that, in exchange for the U.S. guaranteeing the survival of the House of Saud regime by providing a total commitment to its political and security support, Saudi Arabia would:
- Use its dominant influence in OPEC to ensure that all oil transactions would be conducted only in U.S. dollars.
- Invest a large amount of its dollars from oil revenue in US Treasury securities and use the interest payments from those securities to pay U.S. companies to modernize the infrastructure of Saudi Arabia.
- Guarantee the price of oil within limits acceptable to the U.S. and act to prevent another oil embargo by other OPEC members.
The Importance of the Petrodollar System
The need to use dollars to transact in oil, the world’s most traded and most strategic commodity, provides a very compelling reason for foreign countries to keep dollars in their reserves. For example, if Italy wants to buy oil from Kuwait, it has to first purchase U.S. dollars on the foreign exchange market to pay for the oil, thus creating an artificial market for U.S. dollars that would not have otherwise naturally existed. This demand is artificial, since the U.S. dollar is just a middleman in a transaction that has nothing to do with a U.S. product or service. It ultimately translates into:
- increased purchasing power and a deeper, more liquid market for the U.S. dollar and Treasuries…and
- the unique privilege of the U.S. not having to use foreign currency but rather using its own currency, which it can print, to purchase its imports, including oil.
The benefits of the petrodollar system to the U.S. dollar are indeed difficult to overstate.
The Weakening of the Petrodollar System
The geopolitical sands of the Middle East have been rapidly shifting as evidenced by:
- The faltering strategic regional position of Saudi Arabia,
- the rise of Iran which is notably not part of the petrodollar system,
- failed U.S. interventions, and
- the emergence of the BRICS countries providing potential future alternative economic/security arrangements
and all affect the sustainability of the petrodollar system.
The relationship between the U.S. and Saudi Arabia is deteriorating . The Saudis are furious at what they perceive to be the U.S. not holding up its part of the petrodollar deal. They believe that, as part of the U.S. commitment to keep the region safe for the monarchy, the U.S. should have attacked their regional rivals, Syria and Iran, by now. This would suggest that they may feel that they are no longer obliged to uphold their part of the deal, namely selling their oil only in U.S. dollars.
The Saudis have even gone so far as to suggest a “major shift” is underway in their relations with the U.S.. To date, though, they have yet to match actions to their words, which suggests it may just be a temper tantrum or a bluff. In any case, it is truly unprecedented language and merits further watching. A turning point may really be reached when you start hearing U.S. officials expounding on the need to transform the monarchy in Saudi Arabia into a “democracy” but don’t count on that happening as long as their oil is flowing only for US dollars.
It was evident long before Nixon closed the gold window and ended the Bretton Woods system on August 15, 1971, that a paradigm shift in the global monetary system was inevitable. Likewise today, a paradigm shift in the global monetary system also seems inevitable.
By considering Ron Paul’s words, “We will know that day is approaching when oil-producing countries demand gold, or its equivalent, for their oil rather than dollars or euros” we will know when the dollar collapse is imminent.
(*The author’s views and conclusions are unaltered and no personal comments have been included to maintain the integrity of the original article. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.)
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