I am not an economist. I am a trader. Therefore I can’t teach you anything meaningful about the elasticity of demand or the Phillips curve. But I can teach you about trend-following, momentum, position-sizing, probability-weighting of trade ideas, risk control, markets overreacting on emotions and the psychological discipline you need to have not to do it yourself.
So what I am about to say about the global economy and the threat to the US AAA credit rating must be taken in that light. I may not know what I am talking about from an economics standpoint. But I can sure tell you how the world works from a trader and risk-taking investor’s point of view. My perspective might be useful when the unthinkable is about to happen.
It’s All Relative
This is the phrase I used to use to teach people about the world of currencies when I was an FX interbank market maker for ten years. In a world of spiraling debt and trade imbalances, the US dollar has seemed poised for an untimely death for most of that decade.
The truth is that currencies of major economies generally don’t go to zero, despite all the parallels you can draw between ancient Rome and the rise and fall of the US. What’s more, the likelihood of American innovation, productivity, and wealth generation remaining on top of the world is much higher and more sustainable than most want to admit.
Still, we have to answer hard questions about exploding debt, unfunded liabilities, runaway spending, and unbalanced budgets that turn deficits bigger than most other economies. I don’t know how to balance the budget and call me somewhat cynical, but I doubt that anyone in Congress really cares to know more than he or she cares about power and the next election cycle.
So, what can we know? In June of 2009, I wrote the following list for Greenfaucet.com in an piece titled "Strong Dollar — The Meaningless Debate." This article and others like it were in response to prognosticators like Larry Kudlow, whom I admire and respect, pounding their fist that quantitative easing would be the death of "king dollar." The writing actually got me invited on his evening show that summer. I’ll explain what happened in a moment.
10 Reasons Not to Worry
1) Little positive correlation between strong equities and strong dollar. In fact, it’s often a negative correlation.
2) "King dollar" was a harsh reality during 2008 credit crisis that took EUR back to $1.25, not a measure of growth. Dollar is still safe-haven of last resort when the defecation hits the rotary oscillator.
3) Decades-long dollar depreciation reconvened in March 2009 with equity bottom and QE-fed commodity "reflation."
4) China diversifying reserves is an old story whose time has come. Will get priced in slowly. No panic here.
5) Bailouts, Deficits, Inflation-Oh My! Generational, systemic crisis needs quantitative easing, more than economy needs fiscal restraint.
6) Global economy needs U.S. economic vitality more than U.S. needs a strong dollar.
7) Can’t have BRIC/EM growth without risk appetite in other major currencies. Can’t have US growth without EM growth.
8) Truth is that EU is in no better shape right now — the euro is not going to $1.75, but if it did, we’ll adapt quite well.
9) Oil — the other gold — and commodities in general are the best inflation hedges, next to equities.
10) US is not a perfect economy, just the best and only game in town. It’s all relative in a global economy of fiat currencies and wealth driven by productivity innovation.
This is by no means a perfect or complete list of "reasons not to worry" about the dollar or the US AAA credit rating. It was just a collection of my dominant thoughts and arguments at the time two years ago. But you can see how many of the ideas persist as relevant and accurate.
Dollar as Scorecard and Symptom
In June of 2010, I expanded on these ideas in more detail as we enjoyed a strong dollar rally for most of the year, just as I predicted it would come back when Europe’s PIIGs started flinging mud. My thesis about the dollar as "scorecard and symptom" was that it would continue to reflect both our vital importance to the global economy as well our obligations. I will reprint portions of that article, with the above title, next time.
The balance between the dollar and other potential reserve currencies is wrought by the fact that few other places to put your money are as secure, even given all our money printing. This is why I say "it’s all relative."
And this is why you have to ask if it really makes any difference if the ratings agencies downgrade the US from AAA to AA this week or next. Who’s really a AAA then? Should we all be graded on a curve?
Wise investors have seen this coming for years. And as much as China won’t like the risks and the impact upon global mood, they are probably also prepared for the worst if some investors should overreact to the downgrade.
See my "Debt Ceiling Compromise is Small C" for more perspective on the watchful eye of China and the unique symbiotic relationship our two economies share.
A Philosophical Viewpoint, Grounded in Real Economic Experience
There you have it. My amateur-economist view of the global economy, currency exchange rates, and sovereign debt. Take it with a grain of salt, or aspirin. Or ignore it completely for now. Just be willing to consider it at some point because I often know what I’m talking about as the list above from two years ago suggests. And I’m just trying to ease peoples’ minds by talking about how the world really moves money and why.
Sadly, they must have found a real economist for that Kudlow show because they bumped me off a few hours before. I know what you’re thinking. "Their loss," right? (I tell myself that Larry was afraid to have that debate with me, but I’m probably going too far now.)
But controversy always seems to make better "infotainment" than excellent predictions. Maybe I need to be more controversial. I’m certainly not going back to school for my MBA, much less a PhD, at this point. The real world school of trading is much more profitable than any degree.
For more on what Emerging Markets mean to US growth, see my recent articles on Caterpillar (CAT), Apple (AAPL), Freeport-McMoRan Copper & Gold (FCX) and Cummins Inc. (CMI) under the Tactical Trading archive.
Kevin Cook is a Senior Stock Strategist for Zacks.com.
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