Life is full of mysteries, but the dollar crash is not one of them. You need to read this article to learn how to ask the right questions, understand what the dollar is up against, and identify the signs indicating the dollar’s final collapse.
The Burning Question: Has The Dollar Collapsed?
The discussion should not only be whether the dollar collapsed or not, it is critical to ask against what. If you turn on the news or listen to CNBC or Bloomberg, you know the dollar has fallen out of bed.
The DXY has gone from 100 to 89, which is huge. Everybody is saying the dollar has collapsed and it's going to continue to go down from 89. I carefully analyzed what that means, and if the statement -the dollar has collapsed- is accurate or not.
The Dollar Index Spot (DXY) is a measurement of the dollar against a basket of other Fiat currencies as the Euro. The latter is about 57% of the basket that comprises the DXY.
The chart above displays the DXY from 2016 to 2020. For my initial analysis, I used a five-year timeframe. On the right, it goes from 90 at the bottom, up to 102.5.
In 2016-2015, DXY was right about 100, then went down a little bit, and in 2017 it reached 102.5.
In 2018 it crashed to around 90, slightly increased, and then remained flat until the Covid-19 crisis, where it rose quite high between 110-120, perhaps even 140. We would have needed a Plaza Accord 2.0.
DXY crashed down once more after a quick spike due to all the stimulus, quantitative easing, repo market infinity, and everything else that the Fed has done. However, I think it's essentially about the Fed monetizing government debt and the new issuance of treasuries.
As of December 2020, DXY dropped below 90, to 89. With everybody saying that the dollar has collapsed, I put it in perspective. It's only gone down about 10% in the last five years.
Would you call that a collapse?
There are other things that the dollar has collapsed against in the past five years, which ironically enough, nobody is talking about:
- Gold: This is first and foremost. The dollar went down around 40% against gold. That means gold went up and the dollar lost purchasing power against it.
- Chapwood Index: My good buddy, Jason Burack, introduced me to it. The Chapwood Index is like Shadow Stats but does a much better job nailing down exactly how much prices have gone up over the past five years in certain cities across the United States. Just as with gold, the dollar fell 40% against the Chapwood Index.
- Housing: We're now at all-time highs, adjusted for inflation, even compared to 2006, the top of the last bubble. Housing has gone up dramatically. In other words, the dollar has lost about 35% or 40% of its purchasing power against real estate.
- Stocks: They've almost doubled in the last five years. The dollar has lost 50% of its purchasing power against stocks.
Bitcoin: Five years ago, it was $200-$300. Today it is worth around $30.000. So, the dollar has lost about 99% of its value against Bitcoin.
The financial media is hyper-focused on the dollar falling out of bed on the DXY. What is crucial to understand is the dollar has collapsed against things that you would want to buy with it: Gold, housing, stocks, Bitcoin, goods, and services.
Will The Crash Of The Us Dollar Continue?
Initially, I took a more holistic approach to answer these questions:
Is the dollar collapsing?
And I think it's crystal clear that in the last five years, the dollar has dropped against everything you would want to buy.
When most people hear about a dollar crash, they're thinking about it through the lens of the DXY, and this is where I want to focus. The dollar is now trading right about 90, or maybe even 89, against the basket of currencies that comprises the DXY.
It is vital to acknowledge that when you look at currencies and their cross rates, there are potentially hundreds or thousands of crosscurrents involved that determine whether or not the individual currency is going up or down concerning other Fiat currencies.
Here are some of the implicated crosscurrents with the DXY:
European Central Bank (ECB): There is “money printing” on their balance sheet because the Euro is almost 57% of the DXY.
- What is the Fed's balance sheet doing?
- How many dollars are being created?
- How much base money, and maybe how much M2 money supply through quantitative easing or quantitative tightening?
Negative real rates: As they have an impact on the dollar and gold, I might add.
M2 money supply:
- How many new currency units in the real economy are being created?
Not just the currency units, but taking it a step further, we have to ask ourselves…
“How many bank deposits or bank liabilities are being created or destroyed in the real economy?”
- Lastly, is the Fed monetizing the debt?
To analyze the crosscurrents above, I examined some graphics, starting with the balance sheet of the Fed compared to the ECB.
I went back 10 years since the GFC, where the ECB was printing money and the Fed wasn't, or vice versa, which means money, bank reserve, and base money. Then I contrasted that to come to some conclusions regarding what is moving the dollar or the Euro.
In 2008, the Fed's balance sheet took off to try to combat the crisis. It went from $800 billion to about $2.5 trillion. Then it plateaued slightly and went up again during QE2, to flatline in 2012.
Compared to the balance sheet of the ECB, the Fed’s did go up during the GFC, then came back down and remained flat. One could assume the dollar dropped during this timeframe from 2009 to 2012.
However, the DXY chart below shows the dollar didn't go down significantly. It was just more choppy during this timeframe. Although this is a significant crosscurrent, it didn't affect the dollar that much back then. I can't find a correlation.
The same occurs from roughly 2013 to 2014 when the balance sheets were going in completely different directions. The Fed was increasing base money significantly, and the ECB was doing their version of quantitative tightening. One could expect the dollar to go down during that timeframe, but it was pretty flat.
The chart below displays the 10 year Treasury yield adjusted for inflation. I wanted to check if there were negative or positive rates during a specific timeframe.
What stood out the most was the period from 2012 to the end of 2013 with negative real rates. The dollar could have gone down during that span. But the graphic of the DXY shows it was pretty flat.
Gold went up during this timeframe, and it's gone up again now in 2020 when we have negative real rates again. So, the conclusion that I would draw is:
Negative real rates, although they may be a crosscurrent, they do not affect the dollar, the DXY index, as much as they affect the price of gold.
You say to yourself, “Okay, George, so the ECB's balance sheet isn't affecting the dollar too much relative to the Fed's balance sheet, nor our negative interest rates. We're kind of going through this process of elimination.
What is affecting the DXY?
What can we focus on how to determine what may happen with the dollar moving forward?
To answer this question, I reached out to my good friend and partner in Rebel Capitalist Pro, Lyn Alden. She is one of the smartest people I know, and she's studied this extensively. Here are her answers straight from Twitter:
That's when we had interest rates spike up to 10% in the repo market, and the Fed had to reverse QT and go back to doing QE. Then she went on to say:
If you don't know what the Shanghai Accord was, it was an agreement in 2016 where they were going to try to devalue the dollar. They, meaning the central banks that were incentivized to have a weaker dollar.
Lyn’s opinion is:
Real rates do matter, but given the global dollar shortage, QE and QT matter even more.
I would add the Fed monetizing the debt while doing quantitative easing matters the most. She also sent me a cart that illustrates her point beautifully:
When the Fed ended quantitative easing, the dollar shot up and plateaued. Then, during this 2016/17 timeframe, when we had the “Shanghai Accord,” the dollar fell out of bed, even below 90.
Then it gradually went back up when the Fed did quantitative tightening. Since then the dollar has come down significantly, back under 90 in December 2020.
I think the key takeaway from looking at those crosscurrents is the main driver for the DXY right now is the M2 money supply.
It has gone up by over 20% in just the last year. Think about that. There are 20% more bank deposits chasing goods and services today than there were just one year ago. This goes back to the Fed monetizing the debt. Let me remind you how that works.
There is the Federal Reserve (balance sheet, assets, and liabilities), the government, and the character named your drunk, insolvent uncle Sam's spending money like the drunken sailor he is.
What does he do to get the money?
He issues treasuries. Normally those treasuries would be purchased by the private sector. They would be taking money out of the private sector, giving it to your drunk, insolvent Uncle Sam, and he would spend it right back into the real economy, so the net effect on M2 money supply would be a wash.
What happens now when the Fed monetizes the debt, those treasuries go directly to the Fed's balance sheet. They're now an asset on the Fed's balance sheet, and the primary dealer banks kind of get in the middle, like a shell game.
The net result is those treasuries go onto the Fed's balance sheet. And to pay for them, they create additional bank reserves in the account of the Treasury, the TGA.
The TGA writes checks against those bank reserves that go back into the real economy, to one of my favorite characters, the average Joe, in the form of a stimulus check.
He deposits that stimulus check with his local commercial bank, which increases the M2 money supply because the government is spending the money into the real economy without taking the money out of the real economy in the first place.
Normally, they would take the money out of the real economy because the average Joe would buy the treasury from your drunk, insolvent Uncle Sam. Then the government would spend that same money back into the economy, redistributing it.
When the Fed monetizes the debt, the treasury goes right to the Fed. They pay for it with newly printed bank reserves, and then those checks go out because the government spends the money.
Instead of it being a net wash, because it first extracted money from the real economy, then added back into the real economy, now all it's doing is adding money into the real economy without extracting it first.
So, the questions you have to be asking yourself to determine what the future has in store for the United States dollar:
What are the probabilities the Fed continues to monetize the government debt?
What are the probabilities the government continues to run huge deficits?
I would say personally, the probabilities of those two things are extremely high. And if that happens, M2 supply continues to go up. The deposits for liabilities in the commercial banking system continue to go parabolic, and this being the strongest crosscurrent for the dollar, most likely over the long run sends it lower, as measured by the DXY.
What is the end game for the dollar?
When will it lose its Reserve Currency Status?
As you can imagine, I can't give you a specific date, but what I can do is give you a chart that I've been looking at.
I think if you focus on this chart and see which direction it's going, it'll give you the information you need to determine if the dollar is in the process of losing its Reserve Currency status.
To get our minds around this, I think reviewed a clip from Mike Green's most recent Real Vision interview, where he gives us his definition of money:
Money is that which cancels the debt. To the government, that's the form of taxes, on an individual or a private basis, that is debt. If you read a dollar bill, it says very clearly. This is legal tender for the extinguishment of all debts, public or private.
If one of the definitions of money is its use to cancel the debt, and we look at debt denominated in specific currencies, it is visible which of those currencies are being used more or less as money itself.
The chart above goes from 2000 to 2018. It is non-bank global debt denominated in four main currencies: United States dollar, Euro, British pound, and Japanese yen.
The blue line is the United States dollar, that's what we should be most concerned with. It went up, peeked out at the GFC, wend down slightly, but then continued on an upward trajectory.
Back in 2000, there was about $2 trillion of global debt. In 2018, there was over $12 trillion in global debt, and I would imagine it's even higher today. Compare that to only maybe four trillion euros, maybe two trillion British pounds, and under a trillion in Japanese yen.
The chart shows us the dollar is being used to create debt far more than any currency.
Let's think this through. We have the United States, Japan, China, and South America:
Currently, global trade, or the majority of global trade, is done in United States dollars. So, they're paying for goods and services from Japan to China in dollars. China to South America, dollars. South America to the United States, Europe down to South America, mostly in dollars.
Nonetheless, the percentage of overall debt in the world, denominated in dollars, tells us the dollar is being used less and less.
If instead of using dollars with transactions, they start to use other currencies, not just one necessarily, the dollar doesn't have to have a replacement. It could happen very slowly by the use of other currencies instead of dollars.
Maybe China starts doing business with South America in Yuan. Or South America starts doing business in Europe in euros, and then between Japan and China, maybe that's done in Japanese yen.
The dollar is being used less. Therefore, the amount of debt seen on the chart above, denominated in dollars, would be going down.
My point is, when the percentage of global debt denominated in dollars starts going down, that's when you know the dollar is losing its World Reserve Currency status.