Guest Post: The Tailwinds Pushing The U.S. Dollar Higher

Tyler Durden's picture

Submitted by Charles Hugh-Smith of OfTwoMinds blog,

If we shed our fixation with the Fed and look at global supply and demand, we get a clearer understanding of the tailwinds driving the U.S. dollar higher.

I know this is as welcome in many circles as a flashbang tossed on the table in a swank dinner party, but the U.S. dollar is going a lot higher over the next few years. For a variety of reasons, many observers expect the dollar to decline against other currencies and gold, the one apples-to-apples measure of a currency's international purchasing power.
The tailwinds pushing the dollar higher are less intuitively appealing than the reasons given for its coming decline:
1. The Federal Reserve printing another trillion dollars (expanding its balance sheet) will devalue the dollar because money supply is expanding faster than the real economy.
2. The Fed is printing money with the intent of devaluing the dollar to make U.S. exports more competitive globally and thereby boost the domestic economy.
Let's examine each point.
1A. If much of the Fed's new money ends up as bank reserves, it is "dead money" and not a factor in the real economy. Fact: money velocity is tanking:
1B. Money is being destroyed by deleveraging and writedowns. This is taking money out of the real economy while the Fed's new money flows to banks.
1C. The purchasing power of the dollar is set by international supply and demand, not the Fed's balance sheet or the domestic money supply.
As for point 2:
2A. Exports are 13% of the economy. A stronger dollar would reduce the cost of oil, helping 100% of the economy, including exporters. Why would the Fed damage the entire economy to boost exports from 13% to 14% of the domestic economy? It makes no sense.
2B. Most U.S. exports are either must-have's (soybeans, grain, etc.) that buyers will buy at any price because they need to feed their people (and recall that agricultural commodities often fluctuate in a wide price band due to supply-demand issues, so if they rise 50% due to a rising dollar, it's no different than price increases due to droughts) or they are products that are counted as exports but largely made with non-U.S. parts.
How much of the iPad is actually made in the U.S.? Basically zero. Is it counted as an export? Yes. How much of a Boeing 787 airliner is actually manufactured in the U.S.? Perhaps a third. Sorting out what is actually made in the U.S. within complex corporate supply chains is not easy, and the results are often misleading.
2C. Many exports are made and sold in other countries by U.S. corporations, and so the sales are booked in the local currency. The dollar could rise or fall by 50% and most of the U.S. corporate supply chain and sales would not be affected because many of the goods and services are sourced and sold in other nations' currencies. The only time the dollar makes an appearance is in the profit-loss statement at home.
Americans tend not to know that up to 75% of U.S. corporations' revenues are generated overseas, in currencies other than the dollar. This may be part of Americans' famously domestic-centric perspective.
2D. Most importantly, the American Empire needs to control and issue the global reserve currency. The Fed is a handmaiden to the Empire; the Fed's claims of independence and its "dual mandate" are useful misdirections.
Some analysts mistakenly believe that Fed policies are aimed at boosting the relatively modest export sector (which we have already seen is a convoluted mess of globally supplied parts, sales in other currencies, etc.) from 13% to 14% of the domestic economy.
This overlooks the fact that the most important export of the U.S. is U.S. dollars for international use. I explained some of the dynamics in Understanding the "Exorbitant Privilege" of the U.S. Dollar (November 19, 2012) and What Will Benefit from Global Recession? The U.S. Dollar (October 9, 2012).

Which is easier to export: manufactured goods that require shipping ore and oil halfway around the world, smelting the ore into steel and turning the oil into plastics, laboriously fabricating real products and then shipping the finished manufactured goods to the U.S. where fierce pricing competition strips away much of the premium/profit? 

Or electronically printing money and exchanging it for real products, steel, oil, etc.?
I think we can safely say that creating money out of thin air and "exporting" that is much easier than actually mining, extracting or manufacturing real goods. This astonishing exchange of conjured money for real goods is the heart of the "exorbitant privilege" that accrues to the issuer of the global reserve currency (U.S. dollar).

It's important to put the Fed's $3 trillion balance sheet in a foreign-exchange (FX) and global perspective:
- The FX market trades $3 trillion a day in currencies.
- Global financial assets are estimated at around $210 trillion. The Fed's balance sheet is 1.5% of global assets.
The key to understanding the dollar and Triffin's Paradox is that as the global reserve currency, the dollar serves both domestic and international markets. Of the two, the more important market is the international one.
To act as the global reserve currency, a currency must be exported in sufficient size to facilitate the gargantuan trade in a $60 trillion global GDP/ $210 trillion global economy. There are only two ways to export enough currency to be remotely useful:
1. Run massive trade deficits, i.e. import goods and export dollars.
2. Loan massive quantities of dollars to nations that will place the dollars in international circulation.
The famous Marshall Plan that helped Western Europe rebuild its economies was just that: a series of large loans of dollars to dollar-starved economies. This was necessary because the U.S. was running trade surpluses in the postwar era and was therefore not exporting dollars.
This leads to a startling but inescapable conclusion: no exporting nation can issue the global reserve currency. That eliminates the European Union, China, Japan, Russia and every other nation running surpluses or modest deficits.
Many commentators are drawing incorrect conclusions from various attempts to bypass the dollar in settling trade accounts. For example, China is setting up direct exchanges where buyers and sellers can exchange their own currencies for renminbi, eliminating the need for intermediary dollars.
This is widely interpreted as the death knell for the dollar. But this misses the entire point of the reserve currency, which is that it must be available in quantity for everyone to use, not just those doing business with the domestic economy of the issuing nation.
Here's a practical example. The $100 bill is "money" everywhere in the world, recognizable as both a medium of exchange for gold, other currencies, goods and services, and as a store of value that is priced transparently (often on the black market). For the Chinese renminbi/yuan to replace the dollar as the global reserve currency, China would need to "export" enough currency to grease trade large and small worldwide, and enough electronic money to act as reserves that support domestic lending in nations holding the reserve currency.
This is yet another poorly understood function of the reserve currency: it acts as foreign exchange reserves, backing up the holder's currency, and as reserves in its central bank that act as collateral for its domestic issuance of credit.
In other words, the U.S. has issued and exported trillions of dollars because this is the necessary grease for global trade, currency stability and issuance of credit by nations holding dollars. The U.S. didn't run massive trade deficits by accident: it needed to "export" more dollars as the volume of global trade expanded.
Issuing credit and loans in dollars wasn't enough, so the U.S. exported dollars in exchange for commodities and goods.
For China to issue the global reserve currency, it would have to decouple the yuan from the U.S. dollar and start running deficits on the order of $500 billion a year.
Many observers think China is preparing to back its currency with gold, and they mistakenly conclude (yet again) this would be the death knell for the dollar. But they haven't thought through how currencies work: their value is ultimately set like everything else, by supply and demand.
In an export-dependent country like China, a gold-backed currency would not be exported in quantity--it wouldn't be "exported" at all, because China "imports" others' currencies in exchange for goods.
Assuming some of the gold-backed currency was exported, it would quickly end up in savings accounts or bank vaults, being a proxy for gold. There will be none available for facilitating trade in the $210 trillion global economy.
This dual nature of money trips up many analysts. Establishing a currency that is "as good as gold" but not exporting it in quantity means it will be hoarded as a store of value and be unavailable to facilitate trade. Money has to act both as a store of value and as a means of exchange.
This is why U.S. $100 bills are carefully stored in plastic in distant entrepots of the world, safeguarded as real money, available as a store of value and as a means of exchange.
Currencies can be exchanged in a Forex (FX) marketplace, but the reserve currency is the "winner take all" in the real world. If you hold out an equivalent sum in various currencies around the world, the trader in the stall will likely choose the $100 bill because he is not sure of the value of the other funny-money in his home currency and he knows he can easily exchange the $100 everywhere.
The other currencies might trade on the FX market at some percentage of the dollar, but in the real world they are effectively worthless because there isn't enough of them available to establish a transparent, truly global market. To do that, a nation has to export monumental quantities of their currency and operate their domestic economy in such a fashion that the currency is recognized as being a store of value.
In a very real sense, every currency is a claim not on the issuing central bank's balance sheet but on the entire economy of the issuing nation.
All this leads to two powerful tailwinds to the value of the dollar. One is simply supply and demand: as the global economy slides into recession, trade volumes decline, and the U.S. deficit shrinks. (It's already $250 billion less than was "exported" in 2006.) That will leave fewer dollars available on the global market.
In the case of the U.S., which exports large quantities of what the world needs (grain, soy beans, etc.) while buying mostly stuff that is falling in price in recession (oil, surplus manufactured goods, etc.), the trade deficit could decline significantly. (It is currently around $40 billion a month.)
And what does a declining trade deficit mean? It means fewer dollars are being exported. The global GDP is about $60 trillion, of which about 25% is the U.S. economy. Into this vast sea of trade, the U.S. "exports" about $500 billion in U.S. dollars via the trade deficit. Put in perspective, it isn't that big compared to the machine it is lubricating.
So what happens when there are fewer dollars being exported? Demand for existing dollars goes up, pushing the "price/cost" of dollars up--basic supply and demand.
The second tailwind is the demand for dollars from those exiting the euro and yen.The abandonment of the euro is already visible in these charts, courtesy of Market Daily BriefingPeak Euros.
We can anticipate this desire to transfer euros and yen into dollars will only increase as those currencies depreciate. Let's say, just as an example, $5 trillion in euros starts chasing $1 trillion in available U.S. dollars. What will that do to the value of the dollar?
Some ask why those selling euros won't buy Chinese yuan. Where are you going to find $1 trillion in yuan? It isn't even convertible on an open market, and since China is an importer of currency, there isn't 1 trillion yuan floating around the global marketplace to buy even if you wanted to.
Many people scoff when I suggest the dollar could rise 50% (i.e. the DXY dollar index could climb from its current level around 80 to 120) or even 100% (DXY = 160) in the years ahead. I know it's the highest order of sacrilege to even murmur this, but if global demand for dollars picks up, the Fed isn't printing nearly enough to dent the rise in the dollar.
As a lagniappe outrage, consider the domestic fallout from a decline in U.S. stocks and the U.S. economy. The Fed's precious horde of political capital will leak away, and its ability to print more money will be proscribed by political resistance and a loss of faith in the Fed's claimed omnipotence.
Any reduction in Fed printing would only limit the quantity of dollars available to global buyers, further pushing up its price on the open market.

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Stuck on Zero's picture

The dollar is going higher all right.  It is moving to the stern of the Titannic as it rises higher out of the water.


GOSPLAN HERO's picture

Toilet paper dollar has become more expensive. 

Stackers's picture

People should also look up Jim Rickards words and vids on explaining the USD/Euro/Yuan love triangle.

I see the FX market remaining insanely choppy with USD gaining traction more from us being last in line of the shit storm about to hit global finance and governments more than anything.

Popo's picture

My problem with this theory -- and I respect the hell out of CHS -- is that every inch the dollar rises will be seen by the central planners as license to print more dollars.   We already know that they believe with religious fervor that "Moar" is better.   They believe that unemployment, productivity and entry into Nirvana come with "Moar".

The only thing holding them back (if anything) is the dollar weakening vis a vis oil and essential non-elastic imports.   But a stronger dollar?   That there's a trumpet in the distance calling for more QE.   

His argument about velocity is right on the money in terms of traditional QE, but it discounts the possibility of non-traditional stimulus like tax rebates and direct injections into the base of the monetary pyramid.  

strannick's picture


""Less trade, less deficets'' therefore implies better economics? This is insanity. He forget about the debt? Or that less trade equals less employment?? Dumb dumb dumb dumb.

The Big Ching-aso's picture

I think 'tailwinds' here really means some big ass farts.

bank guy in Brussels's picture

And what Charles Hugh Smith is REALLY missing here is what is being so insistently described by Jim Sinclair, Jim Willie and many others

That half of the world is already setting up bilateral trade agreements to BYPASS the US dollar as a needed item for trade

The days of the US dollar as global 'reserve currency' for trade is ending but so many Westerners can't or won't see it

The stupid 'Iran sanctions' and locking Iran out of the SWIFT bank-transfer system was the turning point

China, Russia, Brazil, India and the whole non-Nato world saw that 'they could be next' ... Iran today, some other regime-change target tomorrow

Better to trade bilaterally, and set up banking, bartering and trading arrangements that need neither the US dollar, nor the US-Nato housed 'banking transfer' arrangements.

As we get close to half the world's trade ... like that between Brazil and China ... being done directly WITHOUT the US dollar, there will not be much of the ol' reserve currency left

USA and Nato-Europe can be swapping their deteriorating fiatscos with each other

ConfederateH's picture

He also misses the importance of the various Persian oil states accepting dollars for oil as being the primary reason the dollar ever made it to reserve currency in the first place.  Without the oil backing the dollar is toast, and Saudi Arabia could be very vulnerable.

teolawki's picture

And you can guess what happens when, not if, all those excess dollars come flying back home to roost. Whether it is for this reason or some other.

Ayr Rand's picture

Speaking of toilet paper... it looks like Europe is determined to self-destruct and take all investors with it. The European governments are now expropriating bonds from bank bondholders -- which probably means they cannot even exchange them to get the insurance they paid for using CDS. Another template for future restructuring, from The Economist:

The most severe treatment of all was meted out to subordinated bondholders in SNS Reaal, a Dutch bank that was nationalised last month. The state expropriated the bonds outright, not only wiping out investors but also making it almost impossible for them to claim protection from credit-default swaps (CDSs), an insurance policy against default, because they no longer have any bonds to deliver.

NotApplicable's picture

Interesting theories. Too bad they are only applicable to the current model which is wholly unsustainable (unless ZIRP can be fully implemented across the curve without triggering hyperinflation).

Personally, I see "valuations" of currencies as an exercise in moot, as they invalidate themselves before the ink is dry on the paper. Exactly where is the value to be obtained from measuring shit against shit again? Certainly not anywhere I can see within any real economy.

Then again, this is the "new normal," where economic activity consists of front-running the Fed on behalf of TPTB.

Someone please wake me up the instant my purchasing power increases in the real world.

defencev's picture

Interesting theories. Too bad they are only applicable to the current model which is wholly unsustainable (unless ZIRP can be fully implemented across the curve without triggering hyperinflation).

This is a very good point. I would like to call attention to the track record of "the author" who proved to be wrong in 100 percent cases of his predictions. His "theory" does not explain why the Dollar permanently loosing purchasing power and significantly depreciated versus surplus nations currencies over the years. Nobody arguing that China out of blue will announce that their currency is supported by the Gold. They may do it in case of real crisis to avoid the total crash of financial system. That WILL

make renminbi instanteneous substitute of fallen Dollar as a major reserve currency. The scenario of Dollar crash is also pretty obvious:

Either we assume that the world economy will never recover or Fed sooner or later will be confronted with inevitability of rising interest rates. At that point the US government debt may become unsustainable and default will be accompanied by Dollar demise.

The idea that nothing can substitute Dollar because nobody else has printing machines is just plain stupid but what would you expect from this "author"?

socalbeach's picture

Article is complete rubbish, at least as much as I read; didn't make it all the way through.

JOYFUL's picture

Without intending to do so. CHS has hit upon the problem and soution of the 'reserve currency' conundrum.

  1. In an export-dependent country like China, a gold-backed currency would not be exported in quantity,
  2. Assuming some of the gold-backed currency was exported, it would quickly end up in savings accounts or bank vaults, being a proxy for gold. There will be none available for facilitating trade in the $210 trillion global economy.
That "$210 trillion global economy"  is not a trade is an economy of the financialization of trade. Just as the dollar is a representation of 'value' (backed by the full faith and....;lol)the present world economy  is a representation of exchange of goods and services - not the actual  exchange! We do not need further 'representations' of they gold, clamshells, or fiat. We can take the measure of constant fluctuations in the relative values of goods in their respective economies by employing the same tools as were used to good effect for millenia by trading nations... silver and gold will not be proxies of the moneypower... their dynamic interaction will be arbitrators of  value for the basics of life. Grains of sterling..grams of gold. Barley wheat and rye, is where that comes from and where it will lead to. Without the usurers, life will come full circle. No woman no cry!
Passage's picture

No matter which offshore banking haven you hide your money, just remember to keep them in accounts denominated in USD.

SheepDog-One's picture

Dollar going higher....FED's worst nightmare.

gjp's picture

Really?  Working out pretty well for them so far.  Dollar higher, the world still taking their toilet paper in exchange for real manufactured goods and energy, and feeding the biggest stock and bond bubbles in the world.  What's not to like?

syntaxterror's picture

Overpriced US exports is what's not to like for Benny and the Inkjets. Higher US exports costs means less US jobs which means print more!

markettime's picture

Huh....I wonder why my gas bill and food costs keep going up then? If the dollar were really going higher wouldn't we see a drop in these things? I am thinking it is going higher because everyone else is printing money faster then Benny B. 

akak's picture

Anyone, ANYONE who tries to speciously talk about a "rising dollar' is simply talking out of their ass, if they are not actively trying to deceive the listener or reader.

There is a HUGE difference between the actual, real-world value of a (depreciating) currency, meaning its purchasing power, and the exchange rate of that currency relative to another, simultaneously depreciating currency.  There is furthermore an even greater difference between the actual, real-world value of a currency and the value of some highly artificial, contrived and outdated index based on the exchange rates of that (depreciating) currency vs. other, simultaneously depreciating currencies (such as the idiotic US Dollar Index).

Simply put, there is NO SUCH THING as a "rising dollar", or a rising fiat currency in general --- their values invariably and always move in one direction only, which is downward.  Anyone trying to tell you otherwise is either a fool or a liar, or both.

espirit's picture

+1 for you, akak.  Unfortunately, the sheeples don't prefer to understand this very fact.

The weak minded have already lost the war.

thisandthat's picture

Aka, all currencies flush equally, but some currencies flush more equally than others.

Good times ahead for textile fibers manufacturers, though.

SilverDOG's picture

ANY assumption that those who truly control the USD, WANT the dollar to continue; is extensively



The globes current financial implosion, is merely a bloated version of any previous empire collapse.

Get banked; Get F&$^ed.

Stupid Empires.


"Keep stacking my friends"

DosZap's picture

This leads to a startling but inescapable conclusion: no exporting nation can issue the global reserve currency. That eliminates the European Union, China, Japan, Russia and every other nation running surpluses or modest deficits.

Excuse my stupidity, I Call BS, but isn't this EXACTLY what grew us in a Global Powerhouse?,me thinks yes.

We became the most powerful nation on earth by doing exactly what he say's the other countries CANNOT do.

Splain this to me. As I am stupid.


malikai's picture

Those dollars aren't holding out so well in BTC.

We're inches away from 1BTC / 1BBL WTI.

aphlaque_duck's picture

Bitcoin will trade at parity with gold in 2013.

insanelysane's picture

The US dollar and US government continue to be the most "honest" and "trusted" government around when it comes to governments.  People are beginning to see the Euro as a hippie commune with a lot of great thoughts but when it comes to getting anything accomplished...  As for China, they can say they are backed by gold but there is way too much shadow activity going on there for anyone to trust.

McMolotov's picture

For now, we're the least sickly-looking horse in the lasagna factory, nothing more.

Fuh Querada's picture

Yeah welcome to the world of CHS from the "of 2 dicks" blog, where the electronic creation of trillions of new currency units increases the value of those already in existence.

Yen Cross's picture

     Good luck devaluing the $ when all the money you print is causing global iinflation, and countries have to devalue their currencies against the $.

LawsofPhysics's picture

Fiat is now being recognized as fiat, period.  What is the global stock of fiat?  Is it shrinking?  I think not.

kliguy38's picture

are you suggesting there could be "unintended consequences".....hehehhehehe........maybe that's the ultimate goal

LawsofPhysics's picture

Insightful take.  Just one question, what happens if the dollar is not accepted, period?  If the population of people/nations that completely avoid the dollar is small, it probably won't matter, but should that number grow...


I am also wondering why you ignore that rather large military standing behind the dollar.  It's a blessing and a curse, but tell me, how does forceing people to do or accepting anything help the underlying faith in that currency?  I'd argue it doesn't.

Doubleguns's picture

And when the tail winds end we will be a flying fuselage with no wings. Call it a yellow submarine....dive, dive, dive.

JustPrintMoreDuh's picture

Todays lesson : Fiat currecncies A-Y ... BAD.  Fiat currency Z ... GOOD.   Gold? .. bwahahahahaha  

Stuart's picture

Euro to USD is like moving from bow to stern on the titanic.

NoWayJose's picture

Fewer dollars and the Fed wanting to control the issuance of the global reserve currency?  Has this guy been in a coma for the past 10 years?  The Fed is pumping $85 billion a fresh dollars out every month.  If the global economy slows, that will only increase - at least until the bubble pops...

mdtrader's picture

It's like there was no bad news out of Europe at all today. Just incredible. I think I'm giving up on the US markets. They are proxy for nothing.

Stuck on Zero's picture

Paul Krugman!  Is that you?


ATM's picture

How can the dollar be valued based on the supply/demand equation when supply has no upward bound?

SheepDog-One's picture


Hedgetard55's picture

The dollar is going to rise against... what? Other fiat currencies? Purchasing power should be measured against gold or silver, not Euros and yen.


As for this bullshit about the FED QE money not getting into the economy, what? The net affect of the FED buying Treasuries is that the government has that new money to spend into the economy. Whether the entry is on the banks balance sheet for the value of the Treasuries it bought frontrunning Ben, or the FEDs balance sheet makes no difference, the freshly printed fiat is out there. Noticed the price of oil and food lately?

disabledvet's picture

So far it has been rising against gold and silver. "that's another word for God" in my book. While all us Commentarians can safely ignore this if i'm a (competent) money manager I cannot. Gold mining stocks have never partaken of "the juice" and to me this has BROAD and WHOLESALE implications "for the Western World" as you all think you know it. EPIC primer...and a starting point just to unravel this thing.

Jason T's picture

you're on the same page as Armstrong.. who sees euro melting down and huge capital flows into the only place that can absorb .. the US$.