Myths Surrounding The US Dollar
In our last post “Democrats and Republicans Don’t Care About You And The Bond Market Doesn’t Care About Them” we discussed how many pundits show their stupidity by sticking to their opinions without making sure that their view is grounded in reality. In that post we showed how politicians and media hype be damned the bond market doesn’t care much about the potential “technical default”, instead it seems to think that US debts will continue to be paid. So despite all the hullabaloo about how interest rates will skyrocket pushing up the cost of our debt the truth is that bonds are higher/yields are lower over the past five months or so which is coincidentally the same amount of time that the debt ceiling debate has been raging on.
Now it is time to look at the US Dollar. If you ask the average 24 hour news watcher, and it doesn’t matter if it is MSNBC, FOX, or CNN, what the US Dollar has done over the past three years they will usually say it is down. If you ask how much they all guess 10-30%. Luckily for us there is a place called reality and reality doesn’t care what people think, it just is. In this land called reality the US Dollar despite some large gyrations is actually up over the last three years. Don’t believe us? Well take a look at the following chart. (Click on chart to enlarge)
US Dollar Index
As you can see over the past few years it has effectively gone nowhere. Why has this happened? If the US has huge debt and the Fed is mismanaging the monetary base shouldn’t the USD be lower? In a vacuum yes but since currencies do not trade in a vacuum the USD is holding its own. As opposed to equities, fixed income, or commodities the currency market always trades against other currencies. For instance while you could have every stock in the SP500 climb higher the same is not possible in currencies. If the USD goes up then what did it go up against? If the Swiss Franc is down then what did it go down against? This is why currency quotes are always quoted EUR/USD or JPY/USD. For one currency to go up at least one other currency has to go down. So anytime you hear someone on the news say that the (name your currency) is going higher you need to ask against what.
When all currencies trade against each other the resilience of the US Dollar makes more sense. After all the US may have a ton of debt but how are its competitors doing? The Euro Zone is crumbling before our eyes, Japan has an even higher Debt to GDP ratio then the US, and the UK economy is in horrible shape. So while the United States has a lot of issues our largest free floating trading partners do too and this goes a long ways towards leveling the playing field. So until the United States is the only major economy with a debt crisis we will not go into a free fall. Remember to look at reality before you make trading and investment decisions. Do not trade based upon what you want to happen but instead trade off what is actually happening. Distancing yourself from empty opinions will improve your bottom line year in and year out.
Happy Trading,
Disclaimer-In our model portfolio we are currently short the USD/CHF and short the EUR/USD.
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