It’s The US Dollar, Stupid!

By Ed Bugos – Re-Blogged From

Don’t let the bull-tards tell you the stock market over here is falling because of China’s problems, or Grexit, or fear of the nebulous Fed rate hike. We’ll just see about that last one now anyway!

The US asset bubble is the biggest one on the planet today, and it just went pop. The currency too has rallied over the past few years on the fairy tale that everyone else is inflating while the US is about to tighten, which may have been more plausible if they just started telling it now, and the dollar had not yet gained 65% on the Yen, 35% on the CAD, 30% on the Euro or 25% against a basket of trade weighted currencies -on exactly that story. They have been talking that game for a long time in fact. The worst part about it is that it hasn’t been true, at least not until now. The Fed has expanded money the most in the post 2008 environment -more than the ECB, more than the BOC, BOE, SNB, RBA, and probably more than the BOJ if my suspicions are correct.

Even in the past year it has expanded money more than all of those except the ECB, based on recent M1 data from the OECD. In the past 3-5 yrs the US has inflated its money more than China, Russia, and Brazil; in the last 5 yrs it has inflated more than many emerging nation states, including South Africa, Korea, and India.

If this runs contrary to what you hear it underscores what I am saying -i.e., that the USD is over-valued.

Although the Fed ended QE3 late last year and money growth slowed mostly everywhere, including the US after 2011, both the growth rate and the nominal amounts of money created in the US were still greater.

[This was because the banks took back their position in the money creation cockpit in 2014.]

China is increasingly influential in world trade and politics but relative to US assets it is under owned. This is true of the Yuan as a reserve currency too. So I wholeheartedly and emphatically disagree with anyone who would claim that a China collapse can have a greater impact on world financial markets than a US collapse.

However, commodities are different. Their impact on commodity prices is huge. In fact, one reason I don’t buy the China bubble thesis at the moment is because money growth (M1) has collapsed to almost zero there, after peaking in 2010 at over 30% year over year. Their financial bubble popped years ago, and with it the commodity bubble, which basically attests to what I’m saying -i.e., that monetary conditions in places like China, Brazil, and Russia have not been as easy as the media has made out. Now, I argue, contrary to most, that Chinese authorities will use this stock market “crisis” as an opportunity to start a new bubble. They have said as much with the central bank’s response to the margin problem and its decision to devalue the currency.

But in terms of the size and scope of their financial assets, the proportion owned by foreign investors, the amount of money created by the central bank, irrational exuberance and over valuation – i.e., which bubble is bigger and most crowded – the US situation wins hands down. Importantly, we have been writing about a deterioration in the technical condition of the US stock market long before China or Greek jitters resurfaced.

The Importance of Decelerating Money Growth

I’ve covered the negative trend in corporate profits for over two quarters (in the US), as well as the extremes in sentiment and financial valuations. Most relevant in my model was the 2011-14 downturn in US money supply growth, even though it lagged many of the countries that investors think have had the easiest policies.

Austrian economist Frank Shostak made a similar argument recently about the 2011-14 downturn in his US money supply indicator -comparing it to the pre 1929 deceleration, which I thought compared better with the last downturn (2008). But it doesn’t really matter. The important part is the deceleration in money growth.

That is the early trigger for the “bust.” Recall, the boom-bust cycle is the result of an artificial suppression of interest rates. However, interest rates are suppressed due to the expansion of money supply – which is hence the ultimate root cause of the cycle. The lag is variable and can range from 1-4 years. In Mr. Shostak’s article, the pre 1929 decline in narrow money supply growth started in 1925, and ended in 1927 (i.e., 2-4 year lag).

In fact, it started turning up again going into 1928-29; this was the part that matched the 2008 crisis better.

In either case (1929 or 2008), or in most of the cases I’ve studied in the postwar period, I have found that the 5% level has proved to be a good indicator for the bust, which is why I have adopted it in my model.

However, note that we haven’t fallen below 5% since the 2006-08 period (which triggered the last crisis).

For that reason I have been reluctant to short the stock market until this year, when I saw the collapse in the oil boom at the end of 2014. I took that collapse, and the obvious internal deterioration in the stock market over the past year as evidence that the 2011-14 deceleration in money growth may indeed have been enough.

I rationalized that since money growth after 2008 was higher than the historical average, the decline to its long-term average growth rate (~7%), which was about 4% below its average post 2008 level, may have had the same impact as previous declines to below 5%. Regardless, the key engine of money growth since the Fed exited QE3 (but not ZIRP) has been the commercial banks, which ramped bank credit growth back up to the historical norm also near 7% by the end of 2014. After accelerating into the first half, total bank credit growth has slowed to about 5.5% in recent months in the US, suggesting money growth is headed below 5% anyway.


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