How a Soaring Dollar Will Cause Deflation

The U.S. dollar has been slow to challenge the 97.87 peak from last June (see inset), even if its buoyancy has gone more or less according to our forecast. Our long-term outlook for the greenback remains very bullish — so bullish, in fact, that we see the uptrend culminating in a short squeeze that wrecks the global financial system and reduces most commerce to a state of barter.  The initial phase of this scenario would feature a rally in the Dollar Index that tests and then breaches highs near 120 recorded nearly two decades ago. Well before then, however, every profligate dollar-borrower on earth — you know who you are — would be crushed by the burden of having to pay off debts in a super-hard currency. The list of potential losers stretches on and would include, for one, virtually all of the players in a derivatives markets currently valued at more than a quadrillion dollars. You should view every dime of this as ‘unactualized’ deflation in order to understand why the puny central central banks are powerless to prevent it.

Not that they would even try. For, any attempt by the banksters to monetize this black hole of debt when it begins to implode would be tantamount to hyperinflating. And that would be worse than doing nothing at all.  When the crisis hits, perhaps with a few banks failing to open some Monday morning, it will be impossible to roll short-term loans. This will force debtors to settle up in cash, creating a desperate need for dollars. The resulting short squeeze is why deflation rather than hyperinflation is the more likely of the two scenarios to produce a financial day of reckoning.

Bicycling to Soup Kitchens

In a debt deflation those who owe would be liquidated into bankruptcy, pushing their creditors into the same straits. This is computationally unavoidable, since, as the late C.V. Myers once wrote, every penny of every debt must ultimately be paid — if not by the borrower, then by the lender. Although the dire implications of this truism apparently have not registered even dimly on the brains of economists or politicians, you can bet that at least a few banksters can do the math. They will think twice about riding to soup kitchens on motorized, $10,000 trail bikes.

Hyperinflation could conceivably follow deflation, but only after the assets and liabilities on the global ledger have been deflated to zero by waves of bankruptcies. To those who would argue that “the Government” would simply bail out credit markets via monetization, I’ll recommend Adam Fergusson’s When Money Dies: The Nightmare of Deficit Spending, Devaluation, and Hyperinflation in Weimar Germany. As you will come to understand, this cannot happen to the world’s reserve currency, the dollar — at least not immediately and through willful acts of the government, as occurred in Germany in 1921-23.

When the Trumpets Sound

In the meantime, the laborious consolidation that has taken place on the dollar’s charts for the last seven months suggests that the impending breakout above 97.97 will not be strong enough to signal the climactic phase of the dollar’s bull market. This will happen eventually, but not before the trumpets sound from on high. As individuals, we have time to prepare for the worst by paying down our debts. But this opportunity will exist only as long as a feisty stock market affords us the illusion of economic health. Once the inevitable bear market begins, it will be far more difficult and costly to get out of jeopardy. Enjoy the rally while it lasts.