What’s Up With the Dollar?

[ForexGuy]

A recent CBO report suggests the current federal budget trajectory will yield a deficit of nearly 10 trillion (yes I said TRILLION) dollars over the next decade. Assuming we finance that debt we would be looking at interest payments to skyrocket from around 200 billion a year to nearly 1 trillion. To put that in perspective, it means (our interest payment alone) will total more than the Gross Domestic Product of Australia.

What’s the total debt we are projected to accrue over that same time period? About 20.3 trillion or roughly four times what it is today. With U.S. current GDP at around 14.5 Trillion we would be looking at a nearly 100% debt to GDP ratio.

No matter how you slice it, the U.S. is in a serious hurt locker. One need only look as far as their own kitchen table to see what happens when a household spends more than it earns, then borrows to bay the milk man. At some point, it all comes crashing down. You can play a lot of tricky games, opening up new lines of credit, using one credit card to pay off another, skip one bill to pay another, etc. But at some point the reaper comes calling.

When I got out of the military, I was living in a one room studio apartment in someone else’s basement. I was working at a truck yard washing trailers for 8 bucks an hour. I still remember getting the 40 dollar credit card bill in the mail and knowing that I didn’t even have the money to pay the minimum balance ($10). Man how things have changed. Now I have the big house, nice cars, a wife and 2.5 kids. I’m a regular Ward Cleaver. I am proud to say that, except for a rapidly shrinking mortgage payment, I am debt free. My credit card bills are a lot bigger now than they were back then, but they get paid off at the end of each month.

You see, I learned to live within a budget. I got out of debt and have worked hard to stay there. We could drive a lot nicer cars, or live in a bigger house but we don’t. Because of the decisions we have made there is very little that will truly affect us financially.

There are literally hundreds of thousands of Americans who follow the exact same prescription for success that I do. Our government would do well to heed some sage wisdom. “The borrower is Slave to the Lender.”

So what does all this massive debt, unfunded liabilities and entitlements mean for the dollar? Conventional wisdom would suggest that the dollar will implode. The more pessimistic dollar bears out there would say we are witnessing the end of the greenback. Since I’ve never been one for conventional wisdom I’d like to take a hard look at both the technical’s and fundamentals to come up with what I believe is a rather unique view of our current situation.

The Technical’s

I’m going to compare 3 different currency pairs against the dollar to see what current market sentiment looks like. We’ll be looking at EURUSD, GBPUSD and USDJPY.

EURUSD

Prior to the banking crisis in 2008 EURUSD hit a high of just over 1.6000 before quickly plummeting to the 1.23’s. The relief rally took us back into the 1.47’s before the market retested the lows. Since then it was a slow steady climb back toward previous support around 1.5300.

What you should notice from the chart is that the market failed to retest this area. What should have been a natural target point for longs and a natural shorting opportunity for bears was never reached. The market just didn’t have the gas to get there.

Following that failure the market has pressed down in a beautiful AB=CD pattern right into a 1.618 extension. What we would expect now is a rally back up into the 1.42-1.46 area before a continuation of the bearish momentum.

GBPUSD

Pound/Dollar has been moving in a wide channel since about June of ’09. There has been some very nice downward symmetry in this pair as annotated on the chart in blue.

What should be noted is on February 4th the market broke out of this range to the down side and formed another beautiful AB=CD pattern. A quick Fibonacci study shows us that the .618 retracement comes in right at previous structure support which should now become solid resistance. Don’t get fooled by any relief rally that might occur. The market has shown us its intention we are going lower.

USDJPY

Finally we turn to the Yen. Since June of ’07 the market has been in strait decline as any relief met with solid selling pressure. The market put in its initial low 12/15/08, a double bottom on 1/19/09, and finally a last ditch effort on 11/23/09.

Since that time the market has failed to mount a significant rally and now a descending wedge pattern is about to complete. If history and probability count for anything we would expect to see this market break to the upside in favor of dollar strength.

Now to Fundamentals

I’m a simple guy. I guess you could say I’m a blue collar guy in a white collar profession. I’m the product of a public education and if you’ve seen the inside of a collage classroom you’ve got more secondary education than I do.

That being the case, I tend to approach fundamentals differently than most. I use common sense. In order to understand where the dollar is you need to not only look at what’s happening here at home but also what’s happening in the opposing currencies country. Most people look at the massive defects and all the new money being printed or borrowed and assume the dollar must fall in value. While that may be true over the next 5-10 years, it isn’t exactly true today.

John Maldin, one of my favorite writers and analysts has talked recently about the dollar and why we have not seen the decline so many had predicted. His analysis is quite simple. You can’t have inflation when you have falling productivity and decreasing inventories.

Inflation is really a factor of two things.

1. How many dollars are in circulation
2. How fast are those dollars changing hands (velocity of money)

Despite the fact that we have a record number of dollars in circulation does little to spark inflation because vary few of those dollars are being spent. Banks are not lending, companies are not hiring or purchasing inventory. Businesses are not expanding or investing. When that happens we see deflation (unless the government prints money to offset the decline in velocity).

This doesn’t mean we won’t see inflation in the future, but it does mean that as long as the economy continues to struggle any risk to the dollar is limited.

So what about our opposing currencies? Japan has a debt to GDP ratio near 200% nearly double what ours is projected to be in the next decade. Both the EURO Zone and Great Britain have economies, debt to GDP ratios and a banking crisis that far exceed the ones in the U.S. There is simply no good place to protect your money. The greenback is still the only reserve currency and WHEN the balls start to drop the safest place for cash will be in dollars.

Until Next Time – Good Luck and Good Trading

Jason Stapleton

Head Trading Coach

4xtraderslive.com

[adria]

Thanks for the detailed report. I just saw that the EUR/USD recovers stronger after initial dip today. With 1.2045 minor support intact and 4 hours MACD staying above signal line, recovery from 1.1875 might still extend further. But after all, we're expecting strong resistance at 1.2330 to limit upside and bring down trend resumption.

[Egwig]

Originally Posted by adria

Thanks for the detailed report. I just saw that the EUR/USD recovers stronger after initial dip today. With 1.2045 minor support intact and 4 hours MACD staying above signal line, recovery from 1.1875 might still extend further. But after all, we're expecting strong resistance at 1.2330 to limit upside and bring down trend resumption.

I think ActionForex.com would probably agree with you.:D

Egwig:cool::cool:

[Derrick]

Great analysis of USD with leading currencies and the future trends to follows.The great piece of article and i appreciate the insight of the person about the Forex market.