Dollar Index Starting To Break Down

Brad Setser's Follow the Money reports that the dollar index has started to break down.

(emphasis mine) [my comment]

Nothing brings out buyers like higher prices, and other short stories
Posted on Wednesday, July 15th, 2009
By Mark Dow

DXY, a dollar index, looks like it has started to break down. At my firm, Pharo, we have been whispering on the trading desk over the last two days that this was looking increasingly likely. The implications are positive for risky assets [The DOLLARS are the "risky asset"]. Markets play a lot of tricks on investors, and you can't be too certain of anything in times as unprecedented as these, but, to us, it looks like the short dollar trade is "on".

Is there a fundamental reason for this? [Hell yes. I can name seven or more.] Not clear. However, I am pretty confident that if the dollar continues to sell off the way it has started to overnight and this morning, and Treasuries continue to weaken the way they have started to, the stories of debasing the currency and Chinese diversification and the like will bob right back up to the surface. So, there will at least be a fundamental 'story' behind it.

Dollar Index breaks below 79

Treasury yields are heading up again.

The Fed's balance sheet expanded $80 billion

The Fed's balance sheet expanded $80 billion last week (to $2,112 billion from $2,032 billion). The expansion was caused mainly by the purchase of:

A) 10.5 billion Treasury Notes (mainly 1 to 5 year maturity) (nearly worthless)
B) 3.9 billion agency debt (IOUs from Freddie and Fannie) (worthless)
C) 64 billion mortgage (+10 year maturity) (toxic)

Total = 78.4 billion

China fails to sell bonds

The Wall Street Journal reports that China again fails to sell all bills in an auction.

JULY 20, 2009
China Again Fails to Sell All Bills in an Auction

China's Finance Ministry failed to attract enough bids to complete a bill auction Friday for the third time in two weeks, due to inflation expectations and tightness in liquidity caused by a large initial public offering, traders said.

The unsuccessful bill auction comes as
China's money supply and bank lending are expanding rapidly and follows the central bank's sale of three-month bills Thursday that carried a higher yield than a week earlier for a third week in a row.

The ministry sold 18.51 billion yuan ($2.71 billion) of six-month bills on Friday at 1.6011%, less than the planned issuance of 20 billion yuan, traders said. The rate was higher than market expectations of between 1.4% and 1.5%, they said.

The ministry also failed to sell all of the bills offered in two auctions in the prior week.

The People's Bank of China said recently that yuan loans outstanding at the end of June were up 34 from a year earlier at 1.53 trillion yuan, picking up from end-May's 31% rise.

Traders said Sichuan Expressway Co.'s IPO this past week locked up 684.6 billion yuan in subscription funds, hurting demand for the bill sale. They added that IPO-related liquidity pressure won't ease in the near term as China State Construction Engineering Corp.'s offering, set to be the world's largest IPO so far this year, will open to subscriptions on Tuesday and Wednesday.

[On one hand, China is printing trillions of yuan to fund stimulus spending and prop up the dollar, and, on the other hand, China is selling debt to mob up all this printed currency. Now, three auctions have failed, signaling that China is beginning to lose control over money supply. To solve these auction failures. China has three choices:

A) Pull back on spending. This is the least unlikely option.
B) Raise interest rates to attract investors to bond sales.
C) Print less money to prop up the dollar. Any strengthening of the yuan will increase Chinese demand for commodities, driving up prices for the rest of world.

China is likely to both raise interest rates and strengthen the yuan, but not enough to significantly slow the growth of its money supply growth. Over the next three month, China's inflation problem is going to get much bigger, causing more bond auctions to fail. At some point, China will stop raising interest rates and rely entirely on currency appreciation to get its inflation and money supply under control. This will not be good for the dollar.


My reaction: The outlook for the dollar continues to worsen.

1) DXY, a dollar index, has started to break down, falling below 79.

2) It looks like the short dollar trade is "on".

3) Treasuries continue to weaken, with yields heading up again.

4) The Fed's balance sheet expanded $80 billion due to the purchase of 78.4 billion toxic securities.

5) China failed to attract enough bids to complete a bill auction Friday for the third time in two weeks.

6) China's money supply and bank lending are expanding rapidly

7) China's three-month bills carried a higher yield than a week earlier for a third week in a row.

Conclusion: China's failing auctions are especially worrisome because they increase pressure to appreciate the yuan (and depreciate the dollar).

This entry was posted in China, Currency_Collapse, Federal_Reserve, News_Developments. Bookmark the permalink.

24 Responses to Dollar Index Starting To Break Down

  1. Is this related to the flight to real gold?minedeso

  2. Natasa says:

    Wauu Anon,

    You are probably KGB agent - under covered... of course.

  3. Anonymous says:

    Is there a clandestine understanding between the world's two most powerful central banks, the Federal Reserve and the People's Bank of China?

    ... it's not too difficult to make out the broad outlines of how Chinese-American monetary cooperation may be working.

    People's Bank governor Zhou Xiaochuan and other figures in the Chinese leadership seem to use every opportunity to broadcast finely calibrated skepticism over the dollar's future. Such Jeremiahs feed on and -- in turn -- feed doubts about potential American inflation caused by the Fed's quantitative easing and exploding budget deficits.

    But both Washington and Beijing appear to recognize -- whatever the saber-rattling -- that large-scale shifts in the currency composition of Chinese currency reserves are more or less impossible. Roughly two-thirds of Chinese reserves of more than $2 trillion are thought to be held in the greenback.

    Heavy Chinese sales, or even a deliberate policy of diverting export proceeds into Euro or yen by re-dominating sales contracts, would depress the U.S. currency and lower the value of Chinese reserves. It's the well-known Beijing dollar trap. And it has to be said: the Chinese have maneuvered themselves into it of their own volition, and in full knowledge of the potential problem.

    So Governor Zhou's strictures are, to a certain extent, shadow boxing. However, in return for a tacit standstill agreement on the currency composition of reserves, the Americans have to acknowledge that the renminbi's value will rise only moderately.

    If the Chinese continue taking in dollars, logic tells us the Chinese currency can hardly revalue strongly. A signal of the U.S. authorities' acceptance of this state of affairs is that the word "manipulation" for Chinese currency management now clearly is banned.

    There is another, still more intriguing, side to Chinese currency pronouncements. The doubts voiced from Beijing on the dollar's stability, far from unsettling the U.S. monetary authorities, are actually manna from heaven for the Federal Reserve. The Obama administration hardly can go in for years of reckless deficit spending when the country's largest creditor is emitting so many warning signals.

    More importantly, the Fed is getting a certain amount of cover from Beijing for its eventual "exit strategy" -- a reversal of quantitative easing and a rise in interest rates as soon as economic recovery gets under way.

    The Chinese even are giving a strong tailwind to Fed Chairman Ben Bernanke's bid for re-nomination after his initial four-year term ends in January. The reason? With the Chinese appearing to turn the knife through gloom-laden dollar prognostications, President Obama knows that appointing a heavily political successor to Bernanke would be fraught with great risks.

    Any Fed chairman who looks less than squeaky-clean on currency stability is likely to send dollar holders heading for the exits -- and could spark the full-scale currency collapse that Wall Street bears have been growling about for months.

    So, if Obama wishes to replace Bernanke, he can do so only by bringing in a full-scale monetary hawk -- a step that he must rule out on domestic political grounds. The conclusion is that the Chinese maneuverings leave Obama with no choice but to re-appoint Bernanke, whatever the doubts about his stewardship that have arisen in recent months.

    When Bernanke a little later this year eventually is confirmed in a second term of office, what's the betting that a laconic red-rimmed telegram from Governor Zhou will turn up in his in-tray?

    The missive and its contents, of course, will remain secret. We can only guess at the possibility that the two men, just for a moment, will share the opportunity for a modicum of discreet self-congratulation.


    ** Monkey see monkey do, a dollar collapse will not happen for you; monkey see monkey do, a dollar collapse will not happen for you! **

    LOL, fools!

  4. Robert says:

    What good are China's $2T in reserves if it can never spend them?

    They should just forget about them and move on.

    If they abandon the dollar then ironically they will benefit far more by becoming the new defacto reserve currency which is far more valuable than $2T in reserves that they can't spend anyway.

  5. Bowtie says:

    I think china is using the 2T bonds as collateral.

  6. The Chinese are actually in a much better situation than they would be if their only choice was to either sell their reserves or continue to accumulate reserves. The Chinese would lose a large part of the value of their reserves if they spent them but if they don’t spend their reserves their value will be inflated away. The more reserves they accumulate to support their export sector, the more wealth they will transfer to the US as the value of their resources and labor are transferred to the US through highly unfavorable terms of trade. It would appear at first glance that the Chinese are in a situation comparable to what is called “zugzwang” in chess, which is a situation where a player finds himself in a position where he hurts his position no matter what move he makes. However, the Chinese have found a way around this. Instead of selling dollars, they are taking advantage of the temporary strength of the dollar to use their reserves to act as collateral to back the value of credit and their swap lines with other countries.

    As the Chinese continue to use swap lines to purchase and store commodities, the value of the foreign currencies and the value of the stored commodities gradually become a larger percent of China’s store of wealth for the future. Because of this, China’s store of wealth gradually gains real value as the Chinese become less dependent on dollars and Treasuries as reserves of other currencies and commodities increase.This tends to put upward pressure on the Yuan, and because of this China can take advantage of the increasing Yuan strength to offset even more Yuan printing. They can then increase the use swap lines to purchase even more commodities while maintaining a relatively stable currency. As Yuan are transferred to other countries through swap lines, inflationary pressures will decrease in China. This will allow even more purchases of commodities and use of some of these commodities to further stimulate their economy. As the world nears or may have already reached peak oil, China will benefit greatly by storing massive amounts of oil in the underground oil storage facilities they are building. The positive feedback could continue indefinitely as China continues to stockpile increasingly scarce commodities.

    As the Chinese increasingly stockpile commodities, rising prices will reduce the purchasing power of the dollar. The dollar’s purchasing power and the resulting massive consumption by the US is what has supported US economic dominance and the ability to wage war to maintain it.

    The exchange rate that would be determined based only on purchasing power parity between the dollar and the Yuan would be about two Yuan per dollar. However, the actual exchange rate is almost seven Yuan per dollar. This means that if the US can consume about $700.00 of real value in goods from China in exchange for $200.00 with the $500.00 difference being given to the US for free. A significant share of the $500.00 ends up as retailing GDP and increases the real value of US wages and profits. Spending of the retailing wages and profits benefits other sectors of the economy. The US also greatly benefits from reduced prices for manufacturing inputs. The real value of profits and wages are maintained as more goods back the purchasing power of the dollar which strengthens the US economy.

    Continued below

  7. Continued from above:

    The Chinese will gradually stop supporting their export sector in favor of developing their domestic economy. Because of this, instead the value of their labor and resources backing US purchasing power, it will back Yuan purchasing power and the Chinese will be able to purchase even more commodities and increase their economic strength as the US struggles under its massive debt burden. Increasing Chinese economic strength will spread to its trading partners and capital will increasingly be invested in rapidly growing economies rather than in US treasuries.

    The US has long been able to print dollars to leverage the benefits of the dollar’s reserve currency status. For many years as dollars were printed, massive financial services related GDP was generated as stocks and bonds rose in value. In addition, as dollars flowed overseas as dollar printing increased consumer spending, US consumers increased the amount of wealth extraction from the rest of the world as goods of real value increasing flowed into the US and backed the purchasing power of the dollar. Dollars flowed back into the US as a result of Treasury purchases and the positive feedback of rising asset prices and spending related to US prosperity continued. As rising home prices allowed mortgage backed securities that would eventually become largely worthless to be increasingly sold, financial service related export revenue could be increasingly spent on purchases of undervalued imports without increasing US foreign debt. The amount of economic strength that the US has gained in this manner is far more than the amount that is represented by about half a years GDP in debt that the US has accumulated over many years.

    As China accumulates commodities, dollar printing will be increasingly harmful for the US. As dollars are printed, the value of China’s commodity stockpiles will increase in dollar terms. As the happens, dollar printing will not put so much pressure on the Chinese to increasingly support their export sector to supply even more undervalued goods to back the dollar’s purchasing power and allow the US to further leverage the value of the dollar’s reserve status.

    China has gained a large amount of potential economic strength as they have developed their manufacturing base and acquired US technology as they exported to the US. They are now at the point where they could decouple their economy from that of the US and increase their economic strength as a result. Rather than China being in a “zugzwang” situation, it is the US that is such a situation. If dollars are printed, resulting downward pressure on the dollar as dollars are printed will be offset by less and less in economic gains related to leveraging of the dollar’s reserve status. If the US slows down its printing of dollars, its economy will eventually collapse under its debt burden while China’s domestic economy increasingly prospers as commodity prices fall as a result of a drop in US demand. Rather than being in a “zugzwang” type of situation, its more like a situation where China has checkmate in several moves.

  8. Anonymous says:

    @David Alexander

    Wonderful explained article!

    Could you give a time line when this is about to accomplish?


  9. Anonymous says:

    I love the research and analysis that Eric puts into his posts. There's a lot of critism over this post though, in particular, because it doesn't point to a lot of specific facts but only speculative rumors. The initial research and conclusions drawn up from the post on "Hyperinflation will begin in China and destroy the dollar" was brilliant and these subsequent articles are merely trying to provide supporting information that may give the initial article some relevance. Not saying that they do point to specific facts; but, take them with a grain of salt and try not to be so critical of everything that Eric posts!

  10. lec721 says:

    Quite being so nasty, people!!

    A lot of what Eric has precicted has actually happened on a large scale - like the Fed buying Govt Debt.
    Also gold being a hedge against these fiat monetary issues we are having as well as the fact that we have seen precious little Deflation in this last year since the "crash".

    Eric, you are a very smart guy and I appreciate your insights.

    "Anonymous" cowards should not be allowed to comment, especially when they are such jerks

  11. James says:

    One option that the Chinese will probably not consider to fix their issues is quantitative easing, which would theoretically cause run away inflation. Does anyone know what happens to all the unsold debt?

  12. Jane says:

    the only imminent thing that's going to happened is you people still need money to civilize this planet.

    no gold can do it. only paper and digital money can.

  13. stibot says:

    Jane, in my country we have federal budget of 1,100 billions crowns.

    It was published, our banks made a profit of 50 billions, assuming another 50 billions spent on wages and bonuses in bank sector. Not mentioning other costs.

    So around 10 % of money collected were spent to feed bankers, who produce nothing, but are able to move money to and fro.

    If banks produce loss, it doesn't mean they didn't steal peoples' money: simply consider the fact of injecting billions to provide liquidity again.

    In any case you are stolen and we are still talking about bank sector only. It is obvious system needs to produce as many debt as possible to become profitable.

    What is civilized on stealing the wealth from Janes to selected entities?

  14. spira says:

    Well, that's not paper money fault. If you use gold (assume you really have enough of it), the problem will be the same.

    Irresponsible credit creation is the problem, not paper money.

    20th century civilization is completely financed by what your people despised so much, paper & digital money.

    without it, perhaps we are still racing with horse rather than with hipersonic car & aircraft.

  15. Anonymous says:

    When the collapse happens, it will be fast and furious.
    The dollar it is artificially up, because the world wants to suck down the industrial base of USA. And is doing fucking well so far.
    They will do it until they have to choose between they or the US.
    This WILL happen the question it is WHEN !!

  16. This is in response to “anonymous” who asked me about the time frame for China to purchase and commodities by using currency swaps. It is difficult to determine an exact time frame, but it appears that China will benefit most if the purchases occur relatively slowly.

    If the China makes purchases too rapidly, it could cause commodity prices to rise sharply before they reach the size of a commodity stockpile that they want to accumulate. In addition, if China purchase too rapidly, they could cause a sudden collapse of the dollar and a loss of the value of the dollar reserves that they use as collateral. As China continues to stockpile commodities and uses commodities as they develop their infrastructure, a smaller amount of real value in goods will be available for dollars to purchase, especially if they continue or add to their current export restrictions for some materials. As the US continues to print dollars, this will increasingly create a situation where too many dollars are chasing after a smaller and smaller real value of goods with rapidly increasing US inflation. This will tend to create a situation where the dollar could collapse even more easily as their stockpile grows. Whether they respond to this by further slowing down purchases of commodities will depend on to what extent at the time they feel that they could benefit from attempting to maintain the value of their dollar reserves or whether they believe that at the time that it would be best to give up on a hopeless cause.

    Purchasing commodities too slowly adds to the risk that a sudden collapse of the dollar that China has no control over could offset the benefits of purchasing commodites at a relatively slow pace. Because of this, this risk will need to be monitored carefully.

  17. Martijn says:

    @David Alexander

    Are you familiar with this blog?

    It seems to suit your observations.

    Any other recommendations?

  18. Pak says:

    Many guys out there just don't get it, but the news of Chinese failed bond auctions are very important.

    It's great you're monitoring this info.

    The socio-economic situation in China is quite troublesome indeed. I don't know how they manage to show their impressive quarterly GDP growth figures, but the manufacturing sector, especially sectors like textiles and toys, is now suffering as heavily as it did 6 months ago. There are VERY MANY people out of their jobs, and they're NOT getting any benefits.

    The Chinese simply cannot pull back all the liquidity they have unleashed because they won't risk a revolution. Sooner or later they'll start dumping their US assets, first quietly, then openly..

  19. Numonic says:

    Here's another take on the inflation/deflation debate:

    How come when there's talk of deflation/inflation, no one mentions the rising borrowing costs. Cost is a Cost. If borrowing costs are rising, that is inflation. And borrowing costs are rising even as the govt. is doing everything in it's power to stop it from rising. That is inflation. In fact that is hyperinflation. Technically prices are rising in the country more than they ever have. When the govt. is using all it's power(Fed Funds Rate at 0) to try to stop prices from rising and is still failing to the point that massive companies are closing down and banks are failing, that means that prices are rising more than they ever have. That means that prices are rising so high that we need larger bills to pay those prices. Do you understand what I'm saying? All these bailouts, 0 interest rates, closings, mergers and layoffs is to cut costs. what costs you ask? Borrowing costs. And what has been the number one item on not only America but the worlds list to buy in the past several decades? Credit. Yes credit is an item just like anything else and it has a price and right now it's real price is higher than it's ever been. There has never been a time where the govt. was trying harder to bring the price of credit down and on top of that failing. That means more money is being spent on credit than ever in history. If I said more money is being spent on food than ever in history, you would agree that that is inflation, so why wouldn't you say the same about credit? In fact credit has been used more and by more people in the world than food. Credit has been the number 1 item on the worlds list of things to own for several decades. If the price of the most popular thing to own in the world is rising more than ever before why wouldn't you call that inflation? Whether you take the Austrian's definition of inflation(increasing the monetary base) or any other definition of inflation(such as prices rising) we are experiencing it all.

  20. Numonic says:

    spira said...
    Well, that's not paper money fault. If you use gold (assume you really have enough of it), the problem will be the same.

    Irresponsible credit creation is the problem, not paper money.

    20th century civilization is completely financed by what your people despised so much, paper & digital money.

    without it, perhaps we are still racing with horse rather than with hipersonic car & aircraft.

    I don't even know what you're responding to but i've been saying the same thing you're saying. Except that it's too much credit that is the problem, is credit period.

    If gold were as easy to produce as the paper currency we use today, banks would have never went off the gold standard and gold would be in the same position that the dollar is in today.

    But the irony is that due to the enormous amount of debt, the seemingly easy to produce paper currency is now acting like gold did during the great depression right before we went off the gold standard. There has been soo much debt put on top of the paper currency that what was once easy to produce and inconcievable to ever be difficult to produce has become difficult to produce.

    Now there are those that say the problem is too much credit/debt but not many people ask themselves why credit was expanded so greatly and carelessly. When people do discuss the great expansion of credit they tend to turn it in to a Democrat/Republican debate as which side got rich off of it or not, not realizing that the great expansion of credit is the very thing that was needed to increase the value of the bonds and dollar. When you can pay off a credit card with another credit card and do that ponzi scheme over and over, you're technically getting what you "pay for" for free. As long as businesses and companies were doing this, they had no reason to raise prices and this is bullish for the currency. But most of all a credit based currency needs this massive wreckless spending to increase in value. When someone is spending/giving out money like crazy with out care, people see that person as rich and if that person is giving out money like that so recklessly and freely without any problems, another person would trust that if he gave this person spending/giving away all this money some of his money to hold, that there would be a good chance that he would get that money back. So the massive easy lending was like a lure. It lured people in to trusting the bond and thus people accepted the bond and held the bond. But when that bond stops paying out, trust in that bond becomes lost and the bond and thus the currency looses value as companies can no longer participate in the ponzi scheme and are thus forced to charge the "non-fixed" price of the goods they sell or close down.

    Anyway, point is credit is the problem, the paper currency just made the problem last longer and go unnoticed. The problem couldn't last long with gold because gold could not be printed up like the paper currency we use today which are printed up to stop defaults and keep the problem going, untill the situation we have today where the debt has risen to the point that the paper currency at current denominated levels is too hard to produce. And today we see the problem ending. The problem can no longer continue because even the seemingly easy to produce paper currency due to the massive debt above it has become to difficult to produce. The problem(credit) will definitly come to an end within the next 2 years and the "non-fixed" prices of everything will be seen everywhere. And because credit is a tool of total consumption(because even as you are thinking you'll use the credit to produce something, you're definitely taking away the production that would have been done had you worked/produced to get the money you got from the credit), the end of credit will lead to more production. Say goodbye to the era of consumption and hello to the era of production which brings me to my response to Jane about gold and silver...

  21. Numonic says:

    Jane said...
    "the only imminent thing that's going to happened is you people still need money to civilize this planet.

    no gold can do it. only paper and digital money can."

    Jane, nothing can be further from the truth. You are right that we need money but what you think of as money has done nothing but consume.

    You need to educate yourself on how important silver and gold are to running the machines that help produce the food you eat. In a time of mass production people are going to be looking for the most efficient and energy conservative ways to produce things. We are moving from a world of mass consumption to a world of mass production and these metals (gold and silver) have industrial uses that will make the machines we use to produce things more efficient and energy conservative. So even though the metals won't seem to have direct value (such being able to eat the metals) the value will come from the fact that the metals help in a huge way produce the food you do eat amoungst producing other things. The same reason people don't say they can't eat the paper dollars that they work for everyday. The value of the paper dollar isn't in whether it's edible or not, it's in it's bond's credibility and in it's supply in relation to things in the world. If the bond's delivering those dollars looses credibility or those dollars increase in supply more than the supply of things those dollars can buy, that dollar looses value.

    Anyway that is why gold and silver will increase in value. On top of that reason for gold and silver rising in value, the metals will also rise in value in relation to the dollar because there is an enormous load of debt masking the true supply of the metals and in an era of debt destruction, the veil of debt will be removed and the true supply of the metals will be revealed and cause the price of the metals to rise in relation to dollars.

    The reason the debt destruction for the metals will cause the price of the metals to rise while the debt destruction of the dollar will cause the dollar to fall is because the dollar is the currency we use to buy things and pay mortgages and loans and debt. And because of the enormous debt destruction, borrowing costs(which are risk premiums) will rise and companies that want to stay in business will need to find a way to pay these rising borrowing costs, otherwise they will have to close down. So far the debt destruction has caused the govt. and companies to pull all stops and do everything they can to cut the costs of borrowing and that includes bailouts, layoffs, doing the ponzi scheme of selling long term debt, raising taxes, giving out IOUs, etc. everything they can to pull in money to throw at the credit markets to stop the rise in borrowing costs and it's still not enough. One thing that they must do and it's for the survival of the population and to prevent starvation through mass supply destruction caused by the mass failure to meet those rising borrowing costs causing massive amounts of factories and companies to close is to raise prices and to print larger bills.

  22. Numonic says:

    Spira i meant to say: "It's NOT too much credit that is the problem, it's credit period."

  23. @Martijn

    Thank you for referring me to the FOFOA website. You were very correct in seeing that based on my comments I would agree with what he says. I had seen the site before through a link from another site. Although the earlier article that I saw was informative, it wasn’t especially related to the subject I commented on or to other subjects that I am especially interested in so I didn’t make it a point to go back to the site. After having read the recently posted articles on the site, I definitely plan to go back and will post a comment soon. I found much that I strongly agree with in your comments on the website.

    I would recommend “Energy Bulletin” which focuses on energy, but also frequently has articles that discuss economic issues related to other commodities. I would also recommend Jim Willie’s articles in Financial Sense Online, although I sometimes don’t especially like his style of writing.

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