Dreddnomics for Dummies - Part I: Introduction

From where we sit, many people are going to lose everything they have over the next few years and won't even understand what's happening to them even as it occurs. The entire purpose of this blog is to try and educate people enough so that they can make smart decisions about using their money and protecting it in this turbulent time. However, we continue to get messages asking for an "Economics for Dummies"-type of section.

Unfortunately, that's exactly what we thought we were doing. Clearly, though our intent has been good, we have not been successful in getting the message across. Thus, we will attempt to deliver the message in a moderately different manner through this series of Dreddnomics for Dummies.

We are constrained by a few things that make this difficult to do. First, how much does the typical person really need to know? After all, the goal is to understand what's occurring so that people can take the appropriate steps. It is not necessary to know everything about economics to do that (and we hope to not bore everyone to death...). But it's also not very clear on where one should draw the lines between what's valuable, and what's noise.

Second, no matter how you downplay the topic, it's complex. Note that we say "complex" and not "complicated." Economics is the same as any other complex topic--understanding automobile mechanics, constructing a home, writing software, running a business, etc. All of these topics have simple rules/laws/practices associated with them, and then become increasingly complex through adding new features. For example, understanding the basics of home construction is simple enough: one needs a foundation, walls and a roof. The subject gets more complex as we install plumbing, HVAC systems, integrated wiring, multiple stories, and other features. However, as we see, there is a foundation of knowledge (pun intended) for building a home. Everything else is simply an expansion on those fundamental ideas.

Third, we simply don't have much time. From a big picture point-of-view, the hour is very late. Very large risks to your wealth are coming from every direction. Those that recognize the risks and take the appropriate steps will be wealthier. Those that do not will be much, much poorer.

Of all of the concepts associated with the economy that are important to the typical person, arguably the most important is understanding money itself. Unfortunately, most people don't understand money even when they believe they do. Because of this gap in knowledge, they fall prey to all manner of scams from scam artists, companies, and even their own governments. Their very wealth is stolen from them daily, and they have no idea it's occurring. Since it is only out of ignorance that people have their wealth taken from them, it is only through understanding that they can prevent it.

Most people measure their wealth by the amount of money that they have in their bank accounts and by the perceived value of their assets. If you're doing this, you've already lost the battle. Money is not about debits and credits. Money has little to do with creating wealth. Money and capital are not synonymous. If you don't understand these nuances, you are simply waiting for someone to rob you of your wealth. You are a victim of a con artist, company, or government run amok just waiting to happen. As a matter of fact, the more you're saving today, the more your wealth is being stolen from you. Sounds counterintuitive? It is. Arguably, it's deceptive by design. But here we want to focus on what is happening and how it is happening, rather than why. Why is debatable. We don't care so much about why as about how to protect ourselves.

In order to build a house, you must know how to build a solid foundation. Similarly, if you want to protect and grow your wealth, you must understand (at least roughly) how the economy functions. To do that, we will focus on the basics of the economy--how it functions, the various parts of it, and how it would work in its simplest form. After all, before we go putting wiring in, plumbing in, and a second story on the house, we have to understand how the most basic house is built. From there, we can expand the concepts so that you see how money fits into the big picture. You will understand the risks to it, how to get more of it, and most importantly now, how to safeguard it in this perilous time.

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An Update on the Blog...

Just a "programming" note. We will be expanding the blog with a glossary and a few other "ease of use" features based on popular request. Similarly, we ask that reader shoot us an email with topics of discussion they may be interested in. Send it to us at dredd.evry@gmail.com.

We are considering a separate, free newsletter with more relevant short term trading info, information on legal asset protection strategies, and other tidbits that may be useful to those concerned about where we're going. Some of that information we'd prefer not to make widely public, so a more controlled list is a better idea. As usual, we're not interested in selling anyone's information or anything like that. Half of the point of this blog is to help people protect themselves for what's coming...

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Economic Recovery, Confidence, and Fiat Money

We've been tracking the dollar, commodity, and equity movements here at Dredd and showing their interrelationship. What's important to take away from this is simply that the increase in the value of the global equity markets has little to nothing to do with "green shoots" and everything to do with the destruction of the currency.

If you watch any Bubblevision--those financial stations where the reason for market moves changes every 10 minutes--for your information on the health of the economy, let's just say you're going to be sadly disappointed that we completely disagree with the consensus view. There is no economic recovery underway. None. Zero. All effects you see are illusory, as will be revealed in our upcoming latest installment of the "Where?" series.

As we've mentioned before, the root of this problem is debt, pure and simple. There's too much government debt, corporate debt, and personal debt all around the world. In the case of the United States, 70% of the GDP is based on consumption. Guess what? That's much too high a percentage of the economy to be based on consuming things. Given that consumers are tapped out, how can there be an economic recovery without fundamentally restructuring the economy and monetary system? The two are intimately related. Somehow, most of the industrialized economies of the world, notably western Europe and the US, decided that they could develop ideas locally, outsource all of the work, and then buy back all of the things that were produced elsewhere. We have some news for you that you won't see on Bubblevision--that is not sustainable if the balance sheet of the country is negatively effected over time. A country as a whole cannot consume more than it produces, especially on borrowed money (credit). Any business that ran that way would close its doors in short order.

So, how did we all get into this mess and what's going to happen? To summarize the situation in less than a 1000 page report, two ideas have combined to produce the effects we're seeing today. The biggest one is fiat money. That's what we're going to focus on today.

Debt-Based Money
We've commented before on the role of money as a store of value, on how money is created, and similar topics. Given that this is at the root of the global problem, we need to really dig into is some more.

You must realize that the entire monetary world we live in is less than 36 years old. We live in a giant experiment where nations trade with one another based only on a promise. Never before in human history has this been done, and we believe that this experiment will end in the near future.

Prior to 1973, the world had at least some form of gold standard (we will produce an essay on the history of money in the modern era soon). Why gold? We've discussed this before in several articles, but in short, gold just seems to "naturally emerge." In reality we could have a monetary standard based on anything "real." The value with having a commodity based international monetary system is the concept of "no counterparty risk."

Free Beer Tomorrow
At issue is the question of "what is the value of the currency based upon?" Let's look at an example. If I raised chickens, you raised wheat, and there were no money, would you take my promise to pay you in the future continually in exchange for your wheat? You may loan me credit for a period of time since we're so close, but after a while, you need chickens or eggs, or something of value from me. If all I ever give you is a promise that I'll give you something, it is not long before you stop giving me credit. It's like the "free beer tomorrow" sign that sits as a joke in the local bar.

This is a microcosm of what occurs with fiat money. Fiat money is based on debt issuance by the Treasury. Every dollar that exists (or any currency that exists for that matter) is borrowed into existence. So anyone that accepts that currency is accepting a future promise to repay debt. But of course, almost all currency is debt. So how can you repay the debt with money that is itself debt? Obviously you can't. That's the inherent flaw in the system.

At some point, the debt burden, which includes all issued money, becomes impossible to service. It's very counter intuitive, we know, but that's simply how it works.

Under a gold standard (or any commodity-based standard), this is not the case. Instead of countries paying one another with a future promise to pay one another (see how quickly the house of cards starts looking ridiculous?), the payment must be made with something based on tangible goods--a commodity like gold, oil, or food.

This may seem rather pedantic. Does it really matter? Absolutely. Let's look at a relevant example.

The emerging markets, notably China, have been working on building up their economic progress for decades by slowly getting out of the communist, centrally planned economy model (which they know from experience is doomed to failure) and moving toward a more open, market-based economy (note that the trend in industrialized nations, while still free-er than China today, has been moving the opposite direction for decades). As a nation, China's citizens have been investing their labor to produce real things and have been selling those things to industrialized nations in exchange for debt-based money. In reality, this has been a good deal for industrialized nations. They have issued promises to pay (debt-based money) in exchange for tangible goods (regardless of what you may personally think about Chinese quality). It's a good deal. It's akin to me promising to pay you for wheat without ever actually giving you anything in return other than a newly minted IOU.

Note here that the fundamental ability for this system to function depends on confidence. Fiat money systems are inherently confidence games. If you believe that my promise to pay is as good as delivering chicken and eggs, then you will continue to give me wheat for nothing. It's a great deal for me. In order to keep it going, I have to keep promising. At some point, if your confidence starts to waver and you refuse to accept my promise, then I have a problem. Until then, you have a problem but you don't know it as long as I have your confidence.

So, what causes confidence to fail? That's the situation we're facing. The answer is surprisingly simple and obvious. Promising to pay too much too often will eventually cause the game to end. In a fiat currency system, this is simply issuing more and more money (which is more debt) at increasing frequency. And of course, since it is debt, it must be repaid. To repay it, there must be more debt issued. So the cycle is self destructive over time. You cannot pay off debt without more money, but the money itself is debt. At the same time, if you are trying to buy real goods and you have little to offer in exchange for the real goods except debt-based, fiat money, then you must continually create more debt, which is more money, which is inflationary, which then devalues the money, which then required more debt to create more money, which....

You get the point. It cannot be sustained forever. It is a negative feedback loop, a downward spiral.

Again, unlike the fiat, debt based system, a commodity-based currency is not a future promise. Either the commodity exists, or it does not. It's that simple.

This is the real value of something like gold to you in these times, dear reader. Gold is no one else's liability. It has no counterparty risk. No one has to promise it. Either you have it or you do not (which begs the question about why anyone would purchase paper-based gold, like the GLD ETF, since it defeats the purpose in that you must trust a promise that the gold is really there.) No central bank or government can issue more gold than exists. They cannot create it in a lab (like diamonds). It is in finite quantity.

What are Asset Markets Saying?
As we've been discussing in our (almost) nightly technical market commentaries, we see that everything is trading against the USDX. Markets, like the stock market, are rising because the currency is weakening against other currencies. The markets are not forecasting an end to the "recession" (which in our opinion is the beginning of a depression), they are forecasting problems with the money. After all, this "recession" is based on debt levels, which are intimately tied to the currency. This recession is a monetary problem.

So how are the genius central bankers working to solve it? Well, they're creating more debt and money. "Banks aren't lending to consumers, Dredd," you say. True. Consumers are broke and have few future prospects because they have not jobs related to anything except consumer spending (more negative feedback loop). BUT, the total level of debt is still rising. After all, when the consumer can no longer stand more debt, the governments of the world take on the debt for them through "stimulus" programs. (The debt is not declining, it is simply shifting from individuals and companies to the public/government sector.) The problem is that there no real activity going on to structurally fix the economy--to make nations that consume too much produce more. When the "stimulus" runs out, the economy will crash. If the stimulus is pushed too far, then the creditors will refuse to take debt-based promises any longer and the currency will crash.

The only way to fix this problem is to produce more than is consumed over a substantial enough period of time. Given the debt loads that have been created over the last 36 years, there is no way to pay back that debt (especially since it is growing at a faster and faster pace, simply so that it can pay back previously issued debt). Some form of default is coming, either directly or through massive inflation (the hidden tax that robs money of its store of value property). The monetary system is failing. That is what we must prepare against. That is what we are watching closely. Fortunes will be made and lost soon, and the world will emerge a very different place in the next few years.

The Race to the Bottom
It would be remiss to end here without differentiating between the impact of the value of the USDX and inflation. The USDX is not synonymous with inflation, though they are related. We often discuss the effect of inflation being to raise prices. This is true, but inflation is a difficult thing to really measure, and it may be that a fall in the USDX is perceived as inflation when it is not. This is a key point of our next "Where?"article.

The USDX is a feature of the floating exchange system introduced in 1973 after the US officially left the gold standard in 1971. In this system, the value of a currency can really only be measured in terms of another currency (a currency pair). The USDX is an index of the US dollar weighed against the US' key trading partners. When the USDX goes down, it is going down against a defined "basket of currencies." For most goods produced in the US, the USDX has no immediate impact. For good purchased purchased from the key trading partners, the impact is that the price rises.

The US consumer has been the engine of the world for decades. Foreign countries like Japan, Taiwan, China, and much of Europe have prospered because they focused on creating goods to sell to American consumers (essentially transferring American wealth abroad). So many of these economies are entirely based on selling things to Americans, who are now broke (why they're really broke is a yet another essay).

The result may be a currency war--a race to the bottom. These countries devalue their currency through inflation (creating more money) so that their goods are cheaper for American consumers. Every country will do this, to some extent, as long as they are dependent on more foreign consumers than local consumers, and they will devalue their currency against their national competitors. In this case, the USDX can fluctuate, and prices may rise or fall for foreign goods. But do not be confused thinking that the USDX equals inflation or deflation. It is only a measure of currency flows and only affects prices of goods that are not produced locally. Inflation can and will affect prices regardless of the move in the USDX. As such, the USDX is simply a way of showing the rate at which the US is destroying its currency relative to its trading partners.

We will dig into this topic in more detail next week. We just felt it important to ensure that there is a differentiation in your understanding between inflation and the USDX. A down moving USDX is a sign of more confidence abroad, and a rising USDX is more confidence in the US. World asset markets are being bid up based on confidence in the dollar, and nothing more. It is not a sign of economic recovery. It is a sign of confidence in the largest fiat-based player in the game.

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It's Been a Long Day...

And as you've noticed, we're still running behind. Looks like things are running right again, so this time, we will have some interesting information tomorrow.

As for tonight, the dollar has broken down through the pennant. If it stays down tomorrow, it will likely move to test our favorite 78.33 support line. This time, if it falls, it will probably stay down for a while.

As for gold, some would say today's minor pull back while the dollar was down is very negative. It looks quite positive. The divergence shows that gold is starting to take control of what's coming next. This is looking quite powerful and may begin very soon...

More tomorrow. It's just about to get interesting.

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August 19 Market Action - Correlation and Breakouts

It was our intent today to launch the next part of our "Where?" series, but a few computers doing some number crunching decided to create more problems than necessary. Needless to say, that ended up taking priority. Ideally we'll be caught up tomorrow.

In the meantime, here's another bit of analysis on the state of the markets.

First, some correlation views of stocks, commodities, oil, and gold with the USDX. For clarity, lines of support are solid. Lines of resistance are dotted. Blue lines correspond to the USDX behavior. Red lines correspond to whatever asset we're measuring against the USDX.


The correlation remains strong. You can see there's room for the market to move down and the dollar to move up before there should be any concerns.

With the candlestick chart, you can see more clearly that the dollar could rise up to the 80 level and not violate the descending right triangle.


Note that the slow stochastic is working toward oversold. In the shorter term, the dollar is in a pennant formation, and will probably break up or down in the next day or so. It could go either way, though odds favor a continuation of the downtrend.

You can clearly see the support levels. The 50 day moving average is serving as strong resistance.

The commodity complex has been particularly strongly correlated to the dollar until recently, when it has really rallied strongly. Either the commodity complex is ahead of itself (which is dependent on both the dollar and growth in consumption in Asia) or the dollar is behind. We remain generally bullish on commodities in general and believe the strong pullback in the Shanghai Composite Index to be a continuation of the bull run. We believe that eventually, the Chinese markets will become a bubble, but that may yet be a few years out.


Oil appears to have more of a mind of its own. The price correlation is certainly there (being the global reserve currency, commodities, including oil, are traded in US dollars). However, you can see the demand move up at roughly the same point as the rest of the commodity complex pictured above. We know China is stockpiling. The real question is whether or not they can fuel domestic consumption. Outside of the developed world, oil demand is increasing. At this stage, we doubt we'll see oil fall below $60/barrel again--ever.


The correlation in gold is a little different. It does NOT always move opposite the dollar. This is what many people do not realize--gold IS money. It is the money of last resort. In times of panic, gold rises. In times of dollar weakness, gold rises. In our opinion, gold is easily the safest asset out there. Plus, we think it's getting ready to make a big move. A very big move.


Assuming the dollar remains weak, we expect asset prices to rise--primarily on the back of a weakened dollar, not on fundamentals. The assets with good fundamentals will do even better than the nominal rise in asset prices due to the weak dollar alone.

We believe gold will lead that next leg upward. You can see that gold doesn't have much down room compared to the dollar's up room required to stay within the trend.

As sign that it's about ready to move will be if the dollar remains in sideways trading and gold starts to move up--on both up dollar days and down dollar days. That's a sign that it's about to break loose.

Much like the dollar, gold is going to have to make a decision on which way to move very soon.

We are looking for a few more signals to point to a bottom.

That's it for the night. We'll try to get back on track tomorrow.

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Armstrong Cycles and Pattern Projections Paper

As we've mentioned before, one of the tools we use in longer term forecasting is a model of the past enhanced with cyclical influences. Martin Armstrong is, perhaps, the king of economic cyclical forecasting. Here is his latest paper entitled Cycles and Pattern Projections - Two Very Different Types of Analysis. Enjoy.

Cycles&PatternProjections809

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The Beginning of the Next Leg Down, or Just a Correction?

That is the question everyone wants to know. Are we simply consolidating before assets move up, or are we getting ready to turn over and crash again?

It's a difficult question to answer.

The first thing to realize is that trends in the short term lead to events in the intermediate term, which then lead to the long term.

Because of fundamentals, we know the likely outcome of the long term. What is difficult is understanding how the short and intermediate term may influence the long term.

Also, in the very short term (next few days), it is virtually impossible to predict events.

So our goal is to predict primarily the intermediate term changes based on both short term events and trends while keeping in mind the long term possible outcomes.

With that said, one of the main themes we've been discussing is the asset correlation that is occurring. In a critical period such as this, we need to ensure that the fundamental theme of correlation is or is not intact. To check the dollar/stock market inverse correlation, we're plotting the S&P 500 versus the dollar. The inverse correlation is quite easy to see.

Note that since March, the stock market has risen while the dollar has fallen. The down trend of the dollar is showing with the red descending line from March through today. The up trend line of the S&P, which is the best measure of US equities, is shown in blue.

The blue horizontal lines are areas of support for stocks--areas where there will likely be some buying. If and when stocks fall below these levels, it shows increasing degrees of weakness. We expect a pullback to the 970 level, and possibly a very minor bounce. Then a bigger pullback to the 946 level, which is the strong support for the S&P. If this level is breached, we'd get concerned that the short term correction could turn into an intermediate term correction. In m

The red horizontal lines are areas of resistance for the dollar. The first level of resistance is 79.50, which may hold, meaning the dollar move is over. There is a possibility that 79.82. If we break above that level, we're going to be looking at an intermediate term move. That would be a break out of our descending right triangle pattern that formed in March and an indication that we may have trouble on our hands like we did last fall.

Below we have a short term (daily) chart of the S&P 500.

Note that we have an "active" inverse head and shoulders pattern right around the key neckline support level of 946 (purple line). Again, that level is critical. At the same time, we have been running along the upper boundary of the megaphone pattern that we pointed out in prior discussions (green trend lines).

It is definitely time to be cautious. For a continued stock market rally, we'd like to see a pull back to the neckline level of 946 or so, then a turn back to the upside on high volume. The RSI should not fall below the trendlines (the solid red line is the March trend, the dotted red line is the "critical" line.)

At this stage, we believe we'll do just that. A pull back within the area circled and a serious bounce on the trend line. A violation of those trendlines will be a big sell signal.

The chart below is of the intermediate term S&P 500.

Note that we are overbought (Slow stochastic above 80) on this chart. You can also easily see the "possible" active inverse head and shoulders (Only "possible" because the volume didn't really take off when the neckline was pierced). The count for this pattern takes us to 1350! Hard to believe given the lousy economic conditions we have. At this stage, we tend to believe we're simply going to pull back toward the neckline at 950 level and then make a run toward 1350. However, we also believe at this stage that the rally may fail around 1100 due to some proprietary, internal measures. That would be enough to suck in many more bulls before the end. We'll be watching for the RSI to fall to the red trend line and bounce. A break of the trendline will be a warning, though not necessarily a showstopper.

Of course, the dollar governs all. Below is a clearer chart of the dollar since March.

You can see that as long as the dollar stays below the red trendline connecting the rallies, the downtrend is intact in the short term. The RSI is right around 50 right now, and since March, that level has only been violated once. A violation of the 50 level will be a "yellow flag," but not a panic signal unless the equity market also violates the levels described above.

A closer look at the dollar in the last few months can be seen below.

We can see that today, the dollar just touched the key resistance level of 79.55, which is the 50 day moving average. That may hold the dollar down, and if so, it will generally just move sideways within the larger triangle (on the previous chart) until it gets "overbought" on the slow stochastic and turns over. That's our first scenario, and that can happen in a fairly short period of time.

Above the 50 dma, we have the top of the Bollinger Band at 79.82 as resistance.

A breach above that level accompanied by problems in equities, and we're going to have to determine if we're about to revisit the credit crisis again.

We'll finish up with gold.

Longer term, gold is gearing up for a very big move if it can break the 1000 level decisively because of a complex inverse head and shoulders that counts to the 1300 range. In the intermediate term, gold is in a symmetrical triangle, which is going to have to break one direction or the other in the next few weeks. Unless we have a return to the credit crisis, we anticipate the dollar turning over and gold breaking out of the triangle to the upside. If we return to the credit crisis, we anticipate gold and the dollar breaking to the upside. You can't go wrong with gold in this environment.

But when to buy?


You can see the symmetrical triangle clearly here. Maybe a day or two of down movement and the slow stochastic moving to oversold (below 20) will be a good trading entry point. For longer term investment, we are accumulating here since it appears 930 will be difficult to break below.

In summary, either the dollar move is just about done, or we're in for a multi-month run up in the dollar. At this stage, we're not of the opinion that this is anything more than a short term move, but we will know for sure in a few days. With the correlation holding, the implication is potentially a monster move up in stocks, commodities, and especially gold.

However, if the dollar moves up and breaks out of its general downtrend in the next few days, it will be time to move to cash and gold to wait out another crash in markets.

Fundamentally, we know that the Fed and the US government needs the dollar to fall in a controlled manner. We will not be in the business of fighting the Fed as it tries to weaken the dollar over time.

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August 14 Market Action

We'll have a more detailed analysis later today. Suffice to say that when the dollar rallies, the markets correct--it has been the theme for some time. For now, this appears to be a correction only with no clear signs of major market stresses like we saw last year. That could change, but we believe the dollar will resume its downward movement soon.

In the meantime, here's an interesting discussion with Nassim Taleb and Nouriel Roubini. One great point that Taleb makes, we're in the habit now of rewarding failure. Cash for clunkers, money for bailouts, taxation, etc. When you reward failure, you can expect negative consequences over time. Keep your ears out for government programs that reward bad behavior. They're all around us and gaining support.

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