A Dollar On the Rise Isn't 'Strong', It's Chaos

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Last year was the year of the dollar, as in the currency defied expectations and history and went into overdrive. For many, this has been occasion to break out the champagne and declare, definitively, the inauguration, at long last, of the actual recovery. These people, mostly economists, see the world as they wish, of a currency regime geographically divided by physical reality. Thus, the 10.2% increase in the "price" of the trade-weighted dollar is proof that the Fed did get it right after all, as growth differentials and the upcoming end of ZIRP are reflected in the "strong dollar."

The rest of the world is engulfed in economic pessimism and a growing sense of impending chaos once more. The price of oil is not the only signal of that, as almost every industrial commodity on earth has been decimated by much more than an artificially-driven increase in production. Since everything, almost, is priced in dollars, this is almost circular, so they believe, as commodity declines are taken by the "strong dollar" proponents as a tautological currency expression.

The two are very much linked, no doubt, but not in any way that would lead to the expression of "strong." If there is an economic renaissance underway within the US, the rest of the world is utterly perplexed about it. This is not to say they observe jealously from afar the monetary genius of the FOMC's voting committee, but rather they have a much more close relationship with US "demand" that is so incongruous with this currency narrative.

Most people are at least passingly familiar with the roiling troubles in China, if nothing other than nightly news references to some bubble or ghost city here or there. The economic problem of China is thus left as China, with little or nothing to do apparently with the US's fortune of late. That is somewhat mystifying since the Chinese built precisely the marginal economy to take advantage of exactly that kind of "strong" US trend.

During the mania portion of the housing bubble (in the US, to be specific now that they have spread globally) immediately following the dot-com recession, Chinese imports to the United States averaged a 23.5% growth rate (monthly Y/Y); lasting until the middle of 2007 once the financial end of the housing bust really started to bite. Needless to say, US import appetite was expectedly non-existent during the Great Recession, to which the PBOC responded with textbook monetarism to try to "fill in the trough."

In 2010 and 2011, US imports from China averaged 16.6% growth rates, though that average was diminished by a "sudden" reduction in US-based trade activity during the second half of 2011. That latter period just happened to coincide with the last time the "dollar" grew so "strong", though that was minor in comparison to 2014-15. Since then, from 2012 forward, US imports from China averaged only 5.5% through December - less than one-fourth the rate at which the Chinese economy predicated itself.

Unfortunately, that average since 2012 has been pretty consistent despite all the clamor about huge payroll expansion in the US last year. These figures are not in isolation as something like a purely Chinese rejection. From 2004-06, total US imports from the rest of the world, including China, grew at an average yearly rate of 12.5%. From 2012-14, US imports from the rest of the world grew at an average yearly rate of just 2%! There is some reduction in crude oil imports included in that latter figure, but the shale and fracking "miracle" only account for about 1-2% of import growth.

As I said, the rest of the world is confounded over talk among the rest of the world's economists that the US is again a major growth engine. If the current pace of US expansion is a measure of an economic engine, that would explain a great deal as to why the mood across the earth has grown so dour.

Included in that pessimistic chorus are now US CEO's of multinational firms who are running scared of their quarterly earnings reports. The word "dollar" now appears prominently among excuses for results that range from solidly disappointing to downright concerning. Among the latter category was IBM, a major global bellwether for business capital spending pretty much everywhere. Revenue in the fourth quarter fell 12%; twelve! However the company made very sure to "explain" that almost the entire decline was due to the "strong dollar." Adjusting for constant currency, regardless of whether, like the new trend in ad hoc non-GAAP reporting, such internal adjustments are appropriate and consistent, revenue fell only 2%.

That 10% difference takes a lot of sting out of what is another dreadful quarter for IBM, but does not erase it; -2% is not something to cheer. Nor are these scales out of line with times of greater distress as opposed to strength. The last time IBM saw comparable disaster was during the worst period of the Great Recession; in Q2 2009, for instance, IBM's revenue fell by a very similar 11%, of which it was -4% in constant currency. For "some" reason, the "strong dollar" doesn't seem very much like what is experienced in the actual economy.

The movement of currencies, then, would appear to be very much out of alignment with traditional understanding of exchange mechanics. In studying the theoretical history of such things, that really isn't too surprising given evolution on the subject. As is the case with most monetary elements, this goes hand in hand with developing the post-gold world not for trade but for banking.

Milton Friedman was perhaps the leading proponent of floating currencies, as he saw them as liberating the market spirit. His reputation has taken a great deal of harm over this and other similar thoughts, not all of it earned, as his work essentially amounted to making government more efficient in taking "its" slice of the economic fruits. So it was in currencies too.

His most-referenced work on the subject, The Case For Flexible Exchange Rates, was actually pre-written as internal memoranda while employed for the Marshall Plan in Europe. In 1950, Friedman recoiled at the capital controls that were in place and being placed all over the continent. He wanted a market-based approach for not just goods but finance, as he saw government interference was a major hindrance to economic restoration, and thus actual freedom of existence, in post-war Europe. There can be no doubt as to his commitment and intentions toward markets and free liberty, but unfortunately, as the saying goes, intent is most often not nearly enough.

Where most people are wrong about Friedman and floating currencies was that he was very distinct in what he saw as the mechanisms for imbalance. Either you could have an internal monetary policy set by discretion, of the central bank or other means, and market currencies, or it could be the other way. It should never be both as that would lead to perpetual imbalance without self-control or any limiting factor other than the good graces of political forces (even he was wary of the "enlightened" politician, though, as it turned out, insufficiently).

That is essential to the adherence of a currency regime to basic economic principles, those that have fallen out of favor under the more command approach practiced since the 1980's. In his most distilled assertion, floating currencies and the ability to better and more freely adjust financial flows via market-exclusive mechanisms, amounted to a comparison to daylight savings:

"The argument for a flexible exchange rate is, strange to say, very nearly identical with the argument for daylight savings time. Isn't it absurd to change the clock in summer when exactly the same result could be achieved by having each individual change his habits? All that is required is that everyone decide to come to his office an hour earlier, have lunch an hour earlier, etc. But obviously it is much simpler to change the clock that guides all than to have each individual separately change his pattern of reaction to the clock, even though all want to do so. The situation is exactly the same in the exchange market. It is far simpler to allow one price to change, namely, the price of foreign exchange, than to rely upon changes in the multitude of prices that together constitute the internal price structure."

If there is a fault in Friedman's commitment to the marketplace, it exists right here; he presents it as the "best" way to manage monetary affairs, but it really is just an open door to non-market control. If it is "far simpler to allow one price to change...than to rely upon changes in the multitude of prices", that, by extension, might argue for an "impartial" simplification of a command input upon that "one price" rather than the messiness inherent within truly free markets. He argues that markets may be "simplified" by other markets, but modern thinking has taken that argument to mean literally centralization. And thus, floating currencies were not the relief valve of financial adjustment checking the Friedman-approved rise of discretionary monetary policy, especially interest rate targeting, they were the variable that cemented total monetary control in place of true free markets.

Of course, the prevalent means by which currency exchange was to be expressed was the dollar itself, taking the further role of global reserve in a world without them. The lack of convertibility has left no anchor upon which to base much of anything in either finance or economics, breeding no end of contemptible complications that sap resources, innovation and, yes, "strength" as IBM expresses it (and even Harley Davidson; there is something unsettling on an emotional level when the maker of Harleys is distressed about the "strong dollar").

The global solution was to remove the dollar altogether and replace it with "liquidity." This is a subject I have covered without end, and will do so until it finally starts to quench the very visceral curiosity enduring in the world that is desperately seeking some answers to all of this. What happens when you replace the dollar with the "dollar" is not at all what Freidman expected or intended, but exactly like what he argued (simplification = eventual central planning).

With the global "dollar" having become the de facto global standard, the paramount "virtue" of all finance is a financial balance sheet. When the cumulative private balance sheet of all the world's eurodollar participants went into dangerous spasm starting in August 2007, the world's central banks attempted to interject their own balance sheets as a substitute. Even the Federal Reserve, ostensibly thought to be the beginning and end of the dollar, could not do much but stand idly by in confusion and chaos; their dollars did not fit the needed expression of "dollars."

In the practical sense of the global, and even domestic, economy, the expression of questionable words does not actually fit the case. Neither "strong" nor even "dollar" represents the global financial system as it determines not currency flows but volumes of traded bank liabilities. The accumulation of those, which in some very important respects echoes the concept of the "money supply", is dependent on mathematically-expressed perceptions of purely financial factors.

Since about the time the ECB decided to institute a negative rate floor on its policy corridor, there has been a change in perceptions, observed only indirectly, about those financial factors - especially volatility and acceleration of volatility (a portfolio and more complex form of "the Greeks", including VaR). The increase in expected volatility was a result of a combination of factors, but certainly including the continued inability of central banks to deliver on most if not all of their intended results. In very simple terms, global bank balance sheets must adjust to these perceptions. This was far, far different than the financial regime that emerged from the "dollar" chaos of 2011, where central banks essentially the world over promised almost anything and everything.

The eurodollar behavior seems to have taken these promises at face value - and why not? Though these very same central banks were desperately wrong about everything in 2007 and 2008 (and even the early days of 2009), there was a chance they learned what they needed to learn, and it made practical sense not to bet against them (self-fulfilling in many ways). But all that "reflation" did not meet the ends laid out by Milton Friedman's argument from all the way back in 1950.

The purpose of Friedman-type floating currency "values" was to better and more efficiently manage imbalances; these occurrences were not scary forms of defects, but rather the natural course of the messiness of freedom. The eurodollar system that has developed as a tool for monetary control has the opposite intentions. There is nothing about the global "dollar" that suggests any attention to imbalance at all. Instead, all effort is aimed at maintaining "stability", though it is, as Minsky noted, a false and artificial sense of it.

That is the current incarnation of proclaimed simplicity, as if a stable and immense imbalance is desirable. In other words, the size of the imbalance is the independent variable, as there has to be one, as everything else is determined by essentially politics. In fact, the global "dollar" has taken even that "logical" bastardization of Friedman's good intentions to the next derivation, as the "dollar" aims not just the stability of a single imbalance but rather many of them simultaneously all over the world. The distortion is so grand that current monetary thought seeks nothing but the maintenance of all that could destroy it as if that were laudably constant or "strong."

Thus the "strong dollar" is, again, neither strong or a dollar. What economists are cheering is not the financial balance favoring reclaimed American financial standing, and thus a great economic comeback, but rather the growing expression of fear and doubt about those very goals. In that respect, a "rising dollar" is not at all different than the "falling dollar", as both are forms, in opposite directions, of financial instability.

So commodity prices slump not because the dollar signals US economic resurgence, but because traded bank liabilities have become far more difficult. In the mainstream view of the "strong dollar", commodity prices make no sense other than the stated fact of the dollar price. In the eurodollar world, growing intransigence among bank balance sheets very closely aligns and conforms to a world of collapsing commodity prices. Both are expressions, granted often self-referential, of the same concerns and ultimately fears. If finance rules, then even declining finance sets the trend.

It is exasperating to see not economists laud the currency movements, as they have a repeated habit of looking at everything in a manner inconsistent with even mild complexity, but political officials who have nothing but expedience in their intentions to do the same. When the Treasury Secretary affirms his commitment to the "strong dollar", as has all his predecessors living under the "dollar", it only clarifies either his willful misdirection or utter ignorance. Nobody seems to have any notion about what a strong dollar actually means anymore.

The strength of the US dollar, not "dollar" as it has become in the post-Friedman world, lay not in its price but its convertibility. The US banking system was under good and wise pressure to maintain its own good order so as not to threaten the dollar in actual money terms (gold). There was no false sense of stability here; it was a true and honest anchor of the terms of trade and pure economics. Adjustments and imbalances still had to be made, that is true, but they were done so in terms that were easily and readily understood. That did not make it any less messy, in fact often more so, but the measure of imbalance was left, as usual, to political interference; the economy thrived dramatically when left to these hard rules.

The greatest depressions in our history owe themselves not to gold's restraint on monetary freedom, but prior disastrous removal (simplification toward artificial stability) of restraint. That was the case before the devastating depression that began in 1893, expressed as silver agitation, just as it was in the years leading up to the Great Depression (the first great, global experiment with floating and fiat began in 1914 and did not end until 1944 - after total and almost complete global calamity).

Strong dollars were measures of constancy, something that isn't found anywhere in eurodollars. There is no celebration of the "rise" in the price of the "dollar" as it simply means that instability is on the move yet again. Whatever calm and order that appeared as a result of monetary instrumentation after the crisis (that did not stave it off, obviously, in the first place) did not reaffirm such constancy, but rather the same old floating madness that has been apparent for decades now. Somehow that serial asset bubbles have "suddenly" appeared never factors into the "strong dollar" theory of current vintage, especially as their dangerous threat and even collapse has the nasty habit, as an axiom, really, in this currency framework, of coinciding with the "dollar's" sharp rise.

It's not just a matter of "money ain't what it used to be", but rather the literal condition of what that means. A "dollar" on the move so dramatically is not the high water mark of a completed restoration, but rather another indication of how such mess is inherent in it all. That the economy in the US and everywhere else is of similar station is simply the fact that, under the current rules, there can never be an actual strong dollar.



Jeffrey Snider is the Chief Investment Strategist of Alhambra Investment Partners, a registered investment advisor. 

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