|
The Dollar, In Real Money Terms
I have been trading and writing about trading for more than 15 years. Most of the pieces I have written apply the laws and principles of supply and demand to different markets and different topics in an attempt to arrive at true value. I typically use the pure governing dynamics of supply and demand in an attempt to expose the vast array of illusions in global markets and the movement of price. How to identify, quantify, and benefit from supply and demand imbalances to identify value are the goals of my work. Why spend all my time exposing illusion and dealing with touchy subjects knowing that some of the email I will receive might not be that friendly? Because once we sift through the cloud of illusion, we reach a point where we can truly engage in the discovery of truth.
There is a major battle brewing on planet earth that has nothing to do with weapons or physical fighting. It is a most interesting battle that will likely change the shape of global financial dominance here on earth for generations to come. One side has been happy to have this battle while the other side does not even realize they are in a major war. Here are the players:
The World Producers and Savers
- East Asia, China, Japan
- OPEC Hydrocarbon Exporters
VS
The World Consumers and Borrowers
- U.S. Government and U.S. Public
For all of 2006, the United States had a goods deficit of over $800 billion. We in the United States borrow 2 billion dollars a day from the world savers and they expect to be repaid. To look at it another way, we borrow 80% of the world's savings to finance our conspicuous life style. We are 5% of the world's population yet we consume 30% of the world's goods. One of the many ways we do this is to use our home as an ATM. Hard working Asians and oil producing countries consume much less than they produce. Americans on the other hand, produce much less than we consume. The savers and spenders do have something in common however. The workers/producers are happy to receive dollars and the consumers are more than happy to print them. The obvious problem is that this cannot go on forever or foreign companies will own our entire wealth. When we withdraw dollars from our various "ATM's", we are essentially directly depositing them into the ATM's of the worlds producers and savers. When our ATM runs dry, be prepared for major life style changes.
Most Americans have read about this issue or hear about it in the news but they don't realize we are fighting the economic conflict of our lifetime and losing fast for two reasons. First, they are blinded by the illusion of stock market wealth and purchasing power. Second, few in America care about the free falling value of the US Dollar because few understand the US Dollar. The mighty U.S. dollar has tumbled over the past five years and is likely to keep falling. When it comes to illusion in the global financial markets, we are again talking about the difference between the reality of value and the illusion of value. As with trading, those who view value through the eyes of reality typically derive wealth from those who view value through the fog of illusion.
The Illusion of Dow Wealth
Do you receive your monthly statement from your investment broker and smile each time you see the rise in the equity value due to the Dow making new highs month after month? This gain in wealth is an illusion second to none because there is one important number that is missing from your monthly statement. It is the REAL value of the Dow after factoring in the collapse of the U.S. Dollars Global Purchasing Power Parity. What the United States public sees each month is the value of the Nominal Dow which is an illusion of wealth. Let's do the Dow "Real Money index" reality check. How we do this is take the Dow nominal value which is what you see in your monthly statement and multiply it by the U.S Dollars trade weighted index. Before we do this however, please make sure you're sitting and prepared for a disturbing piece of reality. In 2000, the Dow top was 11,700 nominal times 1.24 which was the dollars trade weighted index. This equals 14,508 Global Purchasing Power Parity (GPPP) points. In 2007, the Dow at 13,500 nominal multiplied by a dollar index of .81 equals 10,935 GPPP points. 14,508-10,935 = 3573 points divided by 14,508 = 25% real constant stock market decline!
Despite its recent eclipse of 14,000, the Dow (after accounting for the collapse of the U.S. Dollar) now buys more than 30% fewer Euros than it did back in 2000 when it was priced at approximately 11,700. It also buys 35% fewer gallons of milk, 40% fewer bushels of corn or wheat, 65% fewer ounces of silver, 70% fewer barrels of oil, 80% fewer pounds of copper, and so on. Do the simple math and figure out what the Dow will buy today in terms of other necessities such as housing, insurance, college tuition, or hospitalization. Anyway you measure it, Dow value that most Americans view as great wealth today is worth far less than it was in January of 2000. What about the NASDAQ real money "invisible" crash? Let's do the math:
NASDAQ 2000 Top: 5000
Dollar Weighted Index: 1.24
5000 X 1.24 = 6,200 pts
NASDAQ 2006: 2,500
Dollar Weighted Index: .81
2,500 X .81 = 2,100 pts
6,200 – 2,100 = 4,100 GPPP pts. Divide this by 6,200 at the peak and we have a decline of 66% in real money terms. This is reality!
Understanding the Dollar
The dollar is a "faith based" currency. The unsystematic world monetary system we live in today is a new arrangement. Up until 1971, the dollar was collateralized by gold. If you were a central bank, $35 would get you an ounce on demand. The system gave good, durable service until the U.S. started to run out of bullion. On August 15th, 1971, the dollar became uncollateralized as Richard Nixon took us off the gold standard. Exchange rates started to float, sink, or be pegged. Governments made it up as they went along and still do in many respects today.
I have been trading currencies for around 15 years. For the average person, an easy way to understand how and why they are valued against each other like they are is to think of them as different publicly traded companies. For example, there is typically plenty of demand for the stock of a growing solid company. This demand creates higher valuations for the stock which leads to wealth and strong buying power for the company. There are other companies however like Enron a few years back that were operating under mass illusion. When the public became aware of this fraud, everybody sold the stock which eventually went to zero and the company filed bankruptcy. What happened to the main people responsible for the Enron illusion and fraud? One is serving a long prison sentence and the other died of a heart attack during court proceedings. The Enron illusion was nothing more than risk disguised as opportunity. Currencies are valued the same way. The perception of growth and higher interest rates for a country is going to invite global investors to buy that country's currency which will drive up the value of that currency. The higher the value of the currency, the greater that country's real Global Purchasing Power Parity. If the U.S. and our Dollar were a publicly traded company today, we would be considered much more an Enron than a Microsoft. The currencies of the world producers and savers are much more the Microsofts of the world. Global currencies seek safe and strong returns on investment, the U.S. Dollar is not it and the currency markets have been telling us this for years.
Gold as a Measure of Value
Gold has been the world's real money for 2000 years. In 1932, a man could by a nice suit for $20. We were operating under the gold standard back then, and an ounce of gold cost you $21 in 1920. Today, $20 will not even buy you a decent tie, let alone a nice suit. The one ounce of gold however will still buy you a very nice suit. Gold has held its value; one ounce today is over $700, plenty for the suit.
Gold vs. paper money
Paper money increases (printing money) lead to inflation, inflation leads to higher interest rates, rising interest rates mean a weak bond market, a weak bond market leads to a weak stock market. This is a simple road map based on the past 120 years.
Gold and the Dow
How many ounces of gold (real money) does it take to buy the Dow? Consider this… In 2000, the Dow was at 11,700 and gold was at $250 an ounce. When we divide the Dow value by the price of gold, we get a ratio of 47:1. In 2007, we have the Dow at 14,000 and Gold at $740 an ounce. When we do the simple math again, we end up with a Dow/Gold ratio of 19:1 in 2007. Did the Dow change? No, it's an index of 30 stocks. Did gold change? No, it's an inert element. What changed is the purchasing power of a fiat dollar to buy each asset class. Don't ask yourself: "What is the Dow trading at?" Instead, ask yourself: "What is the REAL Dow trading at?" This may be a radical difference from what you hear from traditional media. They want to have a televised party each time the Dow makes a new nominal high. Why would they cover the issue discussed in this piece? Simple, there is no party when you look at the Dow's decline in real money terms.
An Objective and Preemptive Solution
Now that we are in this mess, how can we fix it, what can we learn from it, and how can we prevent it in the future? There is one answer that takes care of all three questions. Objective supply demand analysis is the key to making sure your quest for true valuation is realistic. Whether you have any intention of trading bonds, currencies, or gold, or not, everyone has a vested interest in knowing how to objectively assess the ongoing supply and demand relationship in these markets. If you have any dollars in the bank, you have every reason to learn how to read a chart of the Dollar. If you have a mortgage on your home, you do have a position in the treasury market and a strong reason to learn how to see supply and demand on a chart of the 10 Year Treasury Note. If you have never looked at a price chart before and feel intimidated by the thought of doing it, be assured that this task is much simpler than you think.
Charts provided by TradeStation.
Area "A" in both occasions on this chart of the US Dollar represents temporary price stability which gives the appearance of supply and demand equilibrium. The decline in price from the levels marked "A" tells us that area "A" was really a price level where supply of U.S. Dollars greatly exceeded demand for them. The initial decline from that level can only happen because of a supply and demand imbalance at price level "A". In other words, there were many more willing sellers of U.S. Dollars than buyers at level "A". Therefore, if and when price revisits price level "A" for the first time "B", we can say that price is revisiting a level where supply greatly exceeds demand "B". In any market, when price is at a level where supply greatly exceeds demand, PRICES DECLINE. When the U.S. Dollar trade weighted index declines, Americans Global Purchasing Power Parity declines. Notice in this example, the initial decline from the first area "A"" is very dramatic. This tells us that there is a very large imbalance at "A" which means we would expect a similar decline at "B". All the answers we need to view markets and discover valuation objectively are incredibly simple, yet the vast majority misses the whole game being played out right in front of them because of the illusions presented to them by those who have more to gain by obscuring reality.
Charts provided by TradeStation.
Here we have a chart of the 10 Year Treasury Note on the left and the U.S. Dollar during the same period on the right. The most attractive trait for a currency is high interest rates. Let's take a look at the chart on the left, the 10 Year Treasury. Area "A" again represents a price level where supply exceeds demand. Again, we know this because price declines from level "A" which can only happen because there are more sellers than buyers at level "A". The first time price revisits that level is at "B" and price declines as we would expect. When treasury prices fall, interest rates are increasing, the relationship of price to yield is inverse.
Now let's look at the chart on the right. Area "A" on this chart of the US Dollar represents temporary price stability which gives the appearance of supply and demand equilibrium. The advance in price from "A" tells us that area "A" was really a price level where demand for U.S. Dollars greatly exceeded supply for them. The initial advance from that level can only happen because of a supply and demand imbalance at price level "A". In other words, there were many more willing buyers of U.S. Dollars than sellers at level "A". Therefore, if and when price revisits price level "A" for the first time "B", we can say that price is revisiting a level where demand greatly exceeds supply "B". In any market, when price is at a level where demand greatly exceeds supply, PRICES ADVANCE. When the U.S. Dollar trade weighted index advances, Americans Global Purchasing Power Parity increases. Let's put this simple relationship of interest rates and the value of the U.S. Dollar together. At the same time interest rates begin to increase, the U.S. Dollar was beginning to turn higher from the demand level. Remember, higher interest rates attracted foreigners to buy dollars (demand). We can see this play out on price charts all the time and well in advance if your point of view is reality based and void of illusion.
The Illusion of Value and The Value of Illusion
Whether we are talking about long term prosperity in financial markets, the true benefits and dangers of the foods we consume, or the health of our most personal relationships, the common denominator in achieving the best outcome lies in your ability to identify the difference between reality and illusion. In the financial markets, quantifying supply and demand objectively will not only allow you to consistently discover TRUE valuation, it will also open a door to low risk/high reward opportunity in the global financial markets. What benchmark are you using to calculate your estate? Is your benchmark a "true" measure of value? My advice would be to use a benchmark void of illusion when determining your global purchasing power and wealth. Even the slightest illusion in the search for truth ensures truth will never be found.
Secular Bear Market
We have had a secular bear market since 2000 in the "Real Money Dow, Nasdaq, and S&P indexes" in terms of Global Purchasing Power Parity. The model of printing dollars and nearly free credit is not the model that built America but it is certainly a model that can destroy it. If we can't sustain our Global Purchasing Power Parity, our standard of living will fall very quickly. In many ways, it already has. You see, illusion teases reality… Don't let the shadow of illusion darken the reality of a trend that may very well change your standard of living soon.
Have a good day.
- Sam Seiden, sseiden@tradingacademy.com
|
|
Sam brings over 15 years experience of equities, forex, options, and futures trading which began when he was on the floor of the Chicago Mercantile Exchange. He has traded equities, futures, interest rate markets, forex, options, and commodities for his personal interests for years and has educated hundreds of traders and investors through seminars and daily advisory services both domestically and internationally. Sam has been involved in the markets since 1991 both on and off the floor of the Chicago Mercantile Exchange. He has served as the Director of Technical Research for two trading firms and regularly contributes articles to industry publications. Sam is known for his trading, technical research, and educational guidance.