One Day Does Not a Trend Make, But...

What a move in the dollar! At the same time, stocks are moving well. Gold, oil, and commodities, however, do not buy it. They're down, but nothing near where one would expect with such a move in the dollar.

One day does not a trend make. Remember that. But, sometimes it is helpful to ponder what trend may develop given certain market moves.

In the 1990s, the dollar did well. The economy was on fire. Commodities were cheap. Unemployment was low...

Much of that was due to being in the early stages of runaway inflation. While we haven't discussed it in detail, it is certainly worth mentioning that price inflation (general rise in prices) does not immediately follow monetary inflation (increase in money supply). There is a lag effect. When inflation occurs, the groups that get the money first, which are the banks, do very well. By the time the money reaches the average Joe, prices have typically risen and the effect of the increased money supply is evident.

The 1990s were marked by inflation that had not yet "hit the streets." The money flowed into dot com stocks and formed a bubble. That's an axiom of inflation--central banks and the government can create money, but once the genie is out of the bottle, you never know where it's going to end up. In the 1990s, it ended up in dot com stocks.

However, during that period, the *perception* was that the US was growing, getting stronger, and could not be stopped. Thus, the dollar, which is the "stock" of the country, rose as did the stock market. That inflationary effect is what central banks hope for. It's good for everyone as long as the party lasts. And the stock of the US, the dollar, as represented by the USDX, went on a tear in the second half of the 1990s because of it:

By the end of the 1990s, the dot com bubble had popped. Combined with the events of September 11, 2001, the US began printing and borrowing money like never before. The economy "recovered" between 2003 and 2007, but it was referred to as a "jobless recovery."

[Side note: How does a country have an economic recovery that doesn't include jobs? George Orwell must be rolling over in his grave.]

The money went to fund wars, and the leftovers went not to create jobs as had happened in the 1990s, but it flowed into housing. Job creation started to occur--in building, brokering, and flipping homes. The rest of the economy was increasingly outsourced abroad, so the new rise in jobs came from people selling stuff made in foreign countries to each other.

The end result was a net loss of capital as money flowed out of the US and into Asia. It was not a real recovery. It was a move where inflation obscured the real price of assets. As such, the dollar weakened throughout the 2000s even as the stock market recovered (remember those terms real and nominal that we covered?) . Costs rose, however, since commodities are priced in dollars and the dollar was sinking fast. That has been the trend of the 2000s.

A lock up in credit markets forced institutions and individuals that had bid up asset prices based on credit to sell those assets and pay off debts. This led to the panic buying of the dollar between March 2008 and November 2008. Aside from that panic period, the trend has been for rising prices and a weakening dollar.

Until *maybe* today.

The dollar is up in a big way. Stocks are also way up on fewer jobless than expected. They have claimed the all important 50% Fibonacci retracement level. Gold and oil don't really buy into this rally, though, as both barely move.

Either we're reentering the 1990s with low unemployment, a strong dollar, the credit crisis behind us, and puppy dogs and rainbows for everyone, or something else is afoot.

The real economy is in very poor condition. Jobs are not really rising, and there's no bubble that is apparent that would create a new round of jobs (like the dot come era or the housing boom). Without new jobs, there will be less consumer spending and a slower economy. Since over 70% of the US economy depends on consumer spending, the GDP must shrink. The last GDP that was "better than expected" was simply the result of government going into debt to prop up the economy because consumers are not able to do so. Do we think this is sustainable? Absolutely not. So why is the market and the dollar rallying? Has the US suddenly gotten more friendly to business, more economically sound, and improved its job based by creating jobs that fuel economic expansion and not consumption? Not no, but hell no. So why are the stores all sold out of puppy dogs and rainbows?

Is is our belief that either today is a one-day blip or the beginning of a euphoric blow-off stage of the March stock market rally. At some point, it will be obvious that the US has not engaged in any meaningful economic reform. There is no real job creation. Business conditions are less favorable with this administration. Inflation is rising. The wars continue. The borrowing continues. The size of government grows. This is not the stuff that stable economies are made of.

Often, before the end of a stock rally, there will be a manic buying phase. It runs until there are simply no more suckers, ahem, I mean buyers left. Without buying, stocks cannot continue to rise unless the dollar weakens. If the dollar is being bid up because of a belief in a return to economic dominance, then it, too, will fall when the last buyer is gone. Barring a return to real economic sustainability, the dollar can only rise due to a temporary technical bounce or the credit crisis, both of which are temporary. In the worst case scenario, all countries print money to keep the value of their currencies in alignment with the dollar, and the USDX remains flat but prices rise. That is the worst case global scenario--global hyperinflation.

Today may be a blip. It may be intervention. We invite the reader to do some research on the Economic Stabilization Fund, or ESF, as a homework exercise.