October 20th, 2010

$US: A Reversal or Consolidation Pattern

In one sense, we’ve been fortunate living in the US because it’s made the value of our savings and assets stable. That may soon be changing however. The high national debt level is interfering with the $US position as the worldwide de facto store of wealth, the place to where everyone runs to protect the value of their assets from political stress, monetary upheaval or military conflict.

The spotlight will be directed again this weekend on foreign exchange as the G-20 group of the central bankers of the top 20 countries meet in South Korea on Friday and Saturday. The burning question is whether or not there’s competition or cooperation among the industrialized countries and the emerging market countries like China, Brazil and Korea in the relative values of their currencies.

To underscore the conflict that potentially might be brewing, the Brazilian finance minister announced he would not attend the meeting. Last month he “accused leading nations that will be represented at the meeting of waging an ‘international currency war’ by devaluing their monies to boost exports at the expense of other nations.”

The problem essentially boils down the thing we’ve been so proud of up to now, our “high standard of living” compared with the rest of the world. That high cost of living has forced us to export manufacturing to the rest of the world due to their lower labor costs and their lower “standard of living”. Now, the rest of the world is thriving on the inflow of funds coming from all that manufacturing while our debts are increasing; the cost of living in those countries are increasing while we’re fearful of deflation.

Money is very liquid and seeks the highest return. A solution is to try to offset that wage differential by changing currency exchange rates: making the Chinese Yuan more valuable, reducing the value of the Dollar, Euro, etc. One way governments do this through changing the competitiveness of various currencies by changing the interest rates governments are paying on their debts.

The exchange rate value of $US in terms of an average index of foreign currencies is:

Technical analysis is probably applied more often and with less controversy to foreign exchange than it is to stocks. When you look at the above charge you can clearly see a confusing picture. The $US exchange rate has been in a narrow range since 2004 between the blue trendlines. Some might see it as a partially formed complex inverted head-and-shoulder with the neckline currently at around 87.50. Others might see a symmetrical triangle with the exchange index currently bouncing off the bottom trendline.

The truth of the matter is that exchange rates are not exactly like stocks, they don’t appreciate or depreciate indefinitely; they fluctuate within ranges. If you see an inverted H+S reversal then you also see some risk in holding your precious metals, materials and foreign stocks. If you see the congestion as a symmetrical triangle consolidation then there could another leg down and precious metals, materials, etc. is a safe place to be.

I’m not sure which I think is the more likely outcome. To much national debt=another move down. Agreement among the finance ministers=reversal pattern and move up. What say you?

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  • Anonymous

    Interest Rates are at a Weekly Cycle Low according to the Hilbert Sine Wave and will be going higher – therefore the Dollar will go lower… it is a Reversal, before the Drop in the Dollar,longer term

  • Anonymous

    I would not be surprised to see dollar strength after this weekend's G20 meeting and into the mid-term elections. However, that dollar strength is likely more cyclical and secular or structural. The structural issues are immense and would require both austerity measures and a reworking of the tax code. Unfortunately, IMO, politicians fail to understand the "real" structural problems; they hope to instill confidence in "nominal" terms.

    In the end – unless and until there is fiscal discipline that is coordinated with monetary action – the dollar debasement will continue.

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