US dollar melt-up

Posted By Darren Winters on Mar 31, 2020

US dollar melt-up

Could a US dollar melt-up be the final stage of this system reset which we could be witnessing in realtime?

“2020 will be the year where humanity and capital make the great escape to safe havens,” as I wrote in a piece entitled, “2020 financial predictions” dated January 9.

My safe haven call, a contrarian view at the time was completely at odds with some of the world’s finest money gamblers like David Tepper who was touting the bull market has legs in January and Ray Dalio’s cash is trash view.

My great escape call to safe havens was a mind’s eye into the future and what could come next is a US dollar melt-up

So as I write this piece in an enforced lockdown (a kind of haven prison) here is my US dollar melt-up view which again is at odds with what some of the heavyweight titan money managers are saying.

The crux to the US dollar melt-up view is based on risk-off demand for haven assets, particularly US treasuries at any price

US Dollar Melt Up

The demand for risk-off assets in these unprecedented times is illustrated by tumbling US 10 Year Treasury Notes yields which are near their historic lows of 0.64 %, at the time of writing this piece.

As capital flows into US 10 Year Treasury Notes that sends prices rising and the corresponding yields lower.

In other words, capital flows into US 10 Year Treasury Notes despite the meager yields of less than 1%, which when factoring in the real inflation rate means that investors are willingly losing purchasing power for the security of getting their capital back.

Put simply, demand for US treasuries and its complement US dollars goes sky-high in a crisis because in a system reset it is not the return on your money that counts but the return of your money.

US dollar melt-up view is based on the idea that central banks create liquidity but like tides of the ocean, they have little or no control, particularly in the era of zero and negative interest rate policy, of where capital flows

So the demand for US treasuries will continue creating a US dollar global liquidity squeeze and a US dollar melt-up despite the Fed’s decision to inject a record amount of liquidity into the financial system with quantitative easing to infinity in response to the pandemic which has shut down the global economy. Despite the Federal government’s record debt, fixed income investors desperate for returns in a corporate dividend drought and zero negative interest rate policy environment will eagerly snap up the new treasuries issued.

So as the US public deficit continues to expand at record levels and the debt becomes monetized that sucks global liquidity for US dollars, creating a US dollar melt-up

Moreover, as the supply of treasuries increases so that the US government can finance its way out of the Greatest Depression, which will also propel the US 10 Year Treasury Notes yields higher.

Think about it. If investors are falling over each other to buy US 10 Year Treasury Notes with yields below 1% don’t you think demand will reach fever pitch when yields go back to normal? 

But higher US 10 Year Treasury Notes yields also increase the opportunity cost of holding precious metals such as gold. Put simply, in this scenario demand for gold falls, sending its price lower and demand for US 10 Year Treasury (paper gold) increases.

In the coming Greatest Depression, I see a US dollar liquidity squeeze which will cause a US dollar melt-up and the meltdown of weaker fiat currencies

But the impact of a US dollar melt-up on the other moving parts of the global financial machine is best understood through the Dollar Milkshake theory put forward by Brent Johnson CEO of Santiago Capital. The impact of a strengthening US dollar can be explained by understanding the crux of the Dollar Milkshake theory, which is based on the dollar strengthening and the fallout that it could have on global markets.

A big “milkshake of liquidity” has been created by the global central banks. 

Dollar Milkshake theory views central bank liquidity as the milkshake and when Fed’s policy transitions from easing to tightening they are exchanging a metaphoric syringe for a big straw sucking liquidity from global markets.

But the fundamental difference today is that global central banks have transitioned back to monetary easing, so it is not monetary tightening that is the metaphoric big straw sucking liquidity from global markets but rather US notes. The central banks’ liquid taps are wide open and the metaphoric straw is now US treasuries sucking up global liquidity which could also lead to a US dollar melt-up.

As US dollar melt-up plays out there is also an emerging currencies meltdown which could also trigger a crisis in emerging markets

The crux to emerging currencies meltdown story is based on the world’s ballooning debt in dollar-denominated loans. As the US dollar appreciates the cost of interest payments rises for borrowers outside the US dollar. So foreign lenders are forced to sell assets to raise finance. But if those assets are priced in their local currencies then they have to sell their currencies and buy US dollars. This can lead to a vicious cycle causing a US dollar melt-up and eventual emerging market loan defaults. 

Perhaps if we go back in time to the 1929 Great Depression we can understand the US dollar melt-up view in a reset

Back then currencies were in a gold standard system with US gold reserves monopolizing the global supply of the precious metal. In other words, the US through its large gold reserves indirectly controlled the world’s liquidity. 

Fast forward to today, a gold standard system no longer exists and we have a fiat debt system with US 10 Year Treasury representing digital gold. So in the Greatest Depression demand for digital gold is likely to soar, if so, US dollar melt-up could be the next chapter into the reset.

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