What Does A Falling Dollar Mean? Consider This...

First of all I wanted to thank my colleague, Bo Harvey for filling in for me yesterday and providing an exceptional column, I trust you all enjoyed it.

The current dilemma facing the dollar has been written about quite a bit lately in the press and specifically in investment/trading columns. To be sure, there are arguments on both sides. However, the overwhelming majority of writers seem to think that the weak dollar is not only NOT a problem, but actually a good thing. I am not here to say one way or the other, the marketplace is simply too large to draw such black-and-white conclusions. However, as I often do, a reference back to history usually offers a glimpse as to the most likely outcome.

Last April, one of my favorite commentators, Marc Faber, wrote a brilliant piece titled: The Curse of Empires. The article had relevance then and even more now. The basic argument/thesis was that throughout  history, empires (Babylonia, Greece, Rome, Spain and Britain) have ultimately sputtered as a result of devaluing their currencies, and ultimately run-away inflation. Some perspective will illustrate this.

Until 27 BC and the rule of Augustus, Romans only used pure gold and silver coins. In order to finance Rome's vast infrastructure expenditures, Augustus ordered that all government-owned mines in Spain and France be exploited 24 hours a day, a measure that dramatically increased the money supply (just like Easy Al and Fed Governor Beranke and his "printing press") and led to higher prices. Augustus, realizing this dilemma, cut back the coinage in circulation dramatically. Despite cutting back the supply of money, the supply was simply transferred into the coffers of the royal treasury.

Fast forward to the rule of Nero. By this time, the accumulated fiscal surpluses in the coffers had been spent and the large trade deficits Rome maintained with its colonies led Nero to debase the currency. "In AD 64, he proclaimed that henceforth the aureus would be 10% lighter in weight." (GDB 4/02.) Additionally, Nero also minted a coin that contained 10% copper. This translated into a coin that was "worth" 25% less than the old one. Nero even went as far to try to re-mint the old coinage in circulation. This only resulted in "hiding" the coins or wealthy individuals emigrating to avoid such a foolish policy. I suspect that in the years to come Mr., I mean, Sir Alan Greenspan will be proven to be just like the Roman emperors before him.

The Debasement of the Roman Denarius

Issuer                        Year                            %Silver

Nero                            54                                94

Vitellius                        86                                81

Domitian                      81                                92

Trajan                          98                                93

Hadrian                        117                              87

Antronius Pius              138                              75

Marcus Aurelius           161                              68

Septimus Severus         193                              50

Elaganbalus                  218                              43

Alexander Severus       222                              35

Gordian                       244                              28

Philip                           244                              0.5

Claudius Gothicus        268                              0.02

Source:  Rolf Bertschi, Credit Suisse Private Banking

The Roman Empire's problems were numerous, including continuous border wars, internal discontent, a heavy dependence on imported goods which led to chronic trade deficits, etc., etc. All of these problems required vast amounts of money to solve, and each time more currency was issued. History shows that the far-reaching efforts of an empire led to its undoing.

While the circumstances were slightly different, the British Empire ultimately gave way to a devalued currency and higher interest rates. From 1915-1988, the British Pound/Swiss France fell from a value of nearly 25 to just over 3. Simultaneously, interest rates on Long-Term Government Bonds went from 3.5% to 15%.

I think it is fair to say that America in many ways resembles the empires of old: far-reaching, great influence, economic vitality and the "bill" to show for it. As Mr. Faber says; "It is expensive to be an empire." The point is simple. A falling dollar is NOT good for our economy. Sure, the argument is that it will help our exporters, but export business accounts for less than 10% of our GDP. More importantly, our situation, like so many historical comparisons, has uncanny similarities to those before us. I want to be perfectly clear. This is not a "sky is falling" article, but before we go arriving at conclusions based on sound-bites, make sure you are well armed with adequate information. Do not listen to this type of nonsense which I read the other day:

"Moreover, the dollar's decline is not a bad thing. In fact, for a long time, the dollar's overvaluation was one of the imbalances that contributed to the slowdown in the US economy. It had to be adjusted, and that is happening now."

Well based on that analysis, Mexico, Argentina and any other country that has devalued their currency in the last five years should be the at the pinnacle of economic growth. Sadly, that is not the truth. 

So, enough of my viewpoint. It is simply something to think about and draw your own conclusions. In the meantime, we need to focus on trading. Luckily these longer-term macro developments do not directly effect our ability to make profitable trades, it is the longer-term positions that run the risk, which is why I remain on the sidelines and simply trade.

Regarding HVT, the plan remains the same, be selective. Each day I continue to find a handful of opportunities in the opening hour, and very little thereafter as the range typically narrows and liquidity becomes an issue. The fact is we are trapped in another trading range, this time between 919 and 925. While yesterday's selloff down to 911 shook things up a bit, the S&Ps managed to close back in the lower portion of the range, 919.

The one area that may offer some hope is the gold sector. I will be the first to admit that it is hit or miss, but when these stocks trade, they trade well. Naturally, developments in the bond market, and more importantly, the dollar, will dictate how these issues trade.

My new trading service, "Dave Floyd's Trading Room," through which I offer live real-time audio commentary, analysis and alerts, is now available. I encourage you to check it out. Click here for more information.

P.S. I also have a new trading module available which teaches how to trade my HVT style through bar-by-bar chart simulations. Click here for information about the module.