If everything in your house started to shrink, would you panic and get out or question what’s wrong with your tape measure? Because financial markets appear to be in turmoil in 2022. Just about everything has crashed. But what’s really going on is very simple. The very measure of prices has changed its value. And that shift explains why everything else seems to be falling simultaneously.
I’m sorry to be cryptic about it, but it’s a pain in the neck to explain the phenomenon I’m on about. It sort of defies explanation, and the enormity of its importance is hard to communicate too. But it could be the most important factor in financial markets in 2022. It is, in my opinion.
It’s easiest to understand in the foreign exchange market. People intuitively know that a falling Aussie dollar against the US dollar equates to a rising US dollar against the Aussie dollar. They’re the same thing.
Or are they?
Well, when the Aussie dollar goes down against the US dollar, which one has actually moved? It’s not entirely clear, is it? How do you distinguish between the two?
If you’re a journalist, it’s easy.
Every day I check the news in the following countries: Australia, the UK, the US, Germany, and Japan. It’s always good fun to notice how the mainstream media, financial establishment, health intelligentsia, and geopolitical experts in each country have a completely different analysis of the same facts but present their views as the only acceptable ones.
Lately, the financial lot have been busy lamenting about the decline of their currencies. Pound sterling has fallen to its lowest since 1984. The euro cracked parity against the dollar — especially embarrassing given the pound was supposed to because of Brexit. The yen fell to 24-year lows. The Aussie dollar got punched in the nose this week, despite the Reserve Bank of Australia’s (RBA’s) latest rate hike.
Cue the opinion columns in local media about why each country’s problems are causing their particular currency to decline against the US dollar. Whether it’s the name of the new prime minister, the lack of babies, fascist politicians, bizarre monetary policy, or a lack of gas, there’s plenty to write about. And then point to the exchange rate as proof.
But if you take one look at the US dollar, you realise it’s a load of rubbish. You see, what’s really going on is a strengthening of the US dollar, against everything. And not just other currencies, but everything. Stocks, bonds, property, Korean exports, Korean imports, etc., etc.
And this one factor also explains the unusual shifts that have occurred in the price of…everything. Back to that in a moment.
The Dixie, a measure of the US dollar against a basket of currencies, is up about 15% this year. The pound sterling is down by the same amount against the US dollar. The euro only a little less and the yen a little more. But you get the idea.
It’s the US dollar that’s the mover, not the pound, the euro, or the yen. Well, the yen really has taken a bit more of a beating against other currencies. But the US dollar’s rise accounts for much more of the yen’s overall drop.
You can add evidence the other way too. The pound isn’t down much in terms of its trade-weighted index, which measures its value against a basket of currencies with which the UK conducts trade. In other words, it’s the US dollar that’s the mover against the pound.
But, like I say, currencies are only the easiest-to-understand example of this phenomenon. If you accept that the US dollar is rising in value, that applies outside foreign exchange markets too.
The US stock market, as measured by the S&P 500, is down about 15% year to date — the same amount the Dixie is up. A broad US Government Bond Index with the ticker code GOVT is down 12%.
The gold price is up in almost all currencies. But not in the US dollar. So did the gold price fall, or did the US dollar go up?
Are prices more generally falling or is the US dollar just becoming more valuable? Yes, this is the same thing, in a way. But the US dollar doesn’t often go on a tear. And so, it isn’t always true that the US dollar is what’s behind those price moves. It is now, though…
What’s going on in the world today is a bit like an earthquake. The ground, which you presume to be immovable, and therefore build your assumptions on, has suddenly begun to move. And so, everything else is shaking.
The US dollar, as the global reserve currency, is the ultimate measure of value. This is easy to understand in commodity markets like gold or oil, where the price is measured in US dollars and then converted back to local currencies, making the exchange rate as important as the gold or oil price. But it’s true of all prices.
We presume the US dollar’s value to be a fixed global measure, like millimetres. But its value can change, shifting the price of everything with it.
And, as prices go, so too do economic fortunes. Because the US dollar is not just used to measure prices but is actively used in international trade, it impacts that trade.
Some of the world’s most prolific exporters have seen their trade balances reverse this year. Germany, Japan, and Korea, for example. While the local media blames this on local factors, it is really the US dollar at work again.
This is especially ironic because it goes against economic conventional wisdom. Normally, weak currencies are good for your trade balance. They make your exports cheaper for other countries and make your imports more expensive, which discourages the locals from buying them. And so, exports are supposed to boom while imports fall as the currency weakens. Indeed, that’s the stated aim of weakening your currency — a popular government policy.
So why has it had the opposite effect this time? Why have currency drops coincided with the reversal of structural trade surpluses for some countries?
It’s not just because economics always likes to teach harsh lessons to people who make presumptions.
The problem with a weak currency is that it makes the imports you rely on more expensive. In this case, energy.
That’s what Korea, Japan, and Germany also happen to have in common — reliance on energy imports. Something they must pay for in US dollars. Which just became more expensive for them. Because the US dollar rose against their currencies, not just because of changes in energy markets.
For the second half of this tumultuous year, whenever you hear about financial or economic news, ask yourself whether it isn’t just the rising US dollar behind it. Or a falling one…
Until next time,
Editor, The Daily Reckoning Australia Weekend
PS: The US dollar might be the world’s benchmark currency right now, but there’s a new currency-type emerging on the global stage. Central banks around the world could be on the cusp of launching their own digital currencies. Could the RBA be one of them? And will this new digital currency help or hinder the way you see and interact with your hard-earned cash? (Some ominous signs suggest the latter.) This new form of money will be 100% digital…and ‘programmable’. What could this mean for your money, your independence, and freedom too? We’ll delve deeper into this topic in the coming days. Stay tuned…