The Dollar, and The Next Ten Days

I’ve never been much of a fan of technical analysis. It’s always struck me as something akin to reading tea leaves—and just as batty. But on the other hand, I’ve seen enough technical analysis deliver accurate predictions that I can’t really dismiss it completely.

Right now, the world is going through a pre-crisis mode—you can practically feel it in the air. The limitless deficit spending by the U.S. Federal government, which has instituted systemic +10% of GDP deficits year after year; the insane Federal Reserve policy of Quantitative Easing 2, which is nothing more than debt monetization as I wrote here, enabling the Federal government’s addiction to deficit spending; the popular uprisings sweeping through the Middle East and North Africa, affecting—wouldn’t you just know it—oil producing countries one after the other; the steadily rising food inflation, which in fact triggered those uprisings in Tunisia, Egypt and Libya, and which are beginning to affect the entire globe; the inevitability of a collapse of the euro—the other major world currency—because of the systemic tensions affecting the European continent, between the strong economies of the north, and the weak economies of the peripheries.

All these issues are bringing renewed pressure on the dollar—though which direction the dollar will react to that pressure is the issue up for debate right now.

The next ten days will be key: Will the dollar spike up? Become the safe haven of everyone fleeing from the world’s troubles? Or will the dollar nosedive, the first big step down in its death spiral?

This is where we’re at—and this turning point is happening now: Right now. Consider this chart, sent to me by my friend in Hong Kong, Michael Hampton:

Click to enlarge.

Technical analysts have all sorts of pet names for various formations—“cup and handle”, “head and shoulders”, etc. I have no idea how tea leaf-readers would call this bouncing off the bottom trendline that we see in this three-year cart—“dribbling the floor”? “Harlem Globetrotting”?

Whatever cutesy name you want to call it, it shows something sort of ominous: It shows the dollar index touching a bottom trendline, just as problems in the rest of the world are peaking.

The two simultaneous problems that are peaking in the rest of the world are rising commodity prices, and rising unrest in oil producing countries.

Michael is a great guy, a very smart man: He’s of the opinion that these two issues ultimately lead to the same thing—extremely high inflation, if not hyperinflation, as I have argued.

But he thinks that, before high inflation starts hitting us all at the grocery store and the gas pumps, there’ll be a risk deleveraging. As a result of this, he’s thinking that there will be a snap-back of the dollar (and the Treasury bond), as people run for cover and/or try covering their risk-on bets.

He sent me another chart, highlighting the euro:

Click to enlarge.

His conclusion off of this chart was that the euro—because of the systemic problems of the continent, of which we’re all aware of—was poised to sink lower: The top trendline was the ceiling it couldn’t breach, just as the dollar’s trendline of the previous chart was the floor it couldn’t break through (for now).

So to Michael, considering the macro perspective of the world’s situation, the risk-on leveraging that has gone on because of the Fed’s ZIRP, and the inevitable flight to safety that will occur/is occurring because of the troubles in the Middle East, there will be a flight to the dollar and dollar-denominated assets (ie. Treasuries)—and a spike up of the dollar index.

At the same time, the euro will spike down, for precisely the same reasons: After all, Europe is one of those global trouble spots.

The above two charts would seem to bear out this analysis: Dollar up, euro down.

Sounds sensible.

But what if we flip the analysis: What if—rather than both trendlines being the floor of the dollar and the ceiling of the euro—these trendlines were broken over the next few days? What if the dollar fell—and the euro rose?

This is not so impossible: Keep in mind that the Germans are particularly averse to inflation—and they are uniquely positioned to do something about it. The eurozone producer price index came out today—and it is rising, signalling an imminent rise in the eurozone consumer price index. Coupled to that objective metric of euro inflation, the ECB has used up its juice with the Germans, insofar as bailing out the PIIGS is concerned—Berlin has no interest in bailing out another eurozone member, no matter how bad the situation gets.

So the ECB will have to stand tough on the euro, or risk hell with the Germans—which the ECB and the other eurozone members cannot afford.

On the other hand, the Federal Reserve is signalling it won’t raise rates even after it has finished buying up Treasuries via QE-2. In fact, it’s not even a sure thing that the Fed will end QE-2, as there are already rumblings of an extension of the policy.

So what if the euro breaks upward, because of the German phobia of inflation? What if the dollar breaks downward, because of Federal Reserve irresponsibility?

As of this morning, the situation looks grim, if you know what to look for: Gold is trading at record levels, after rising overnight. The dollar index has broken below 77, but not decisively, hanging around the 76.8 and thinking it over. Libya’s Gaddafi is striking back at the Eastern Rebels, which is interrupting oil production in the country. And as I mentioned before, this morning, the euro producer price index rose enough to freak out the Germans.

Therefore, today—Wednesday, March 2, 2011—is a key date: Over the next eight trading days, we will see if the dollar rebounds above 77 on the index, or if it bounces back up.

If it bounces back up, we’ve kicked the can down the road a bit.

But if it break lower, then this is the beginning of the death-slide of the dollar.

Stay tuned to your Bloombergs, it’s gonna be a bumpy ride.

If you’re interested, you can find my recorded presentation “Hyperinflation In America” here. I discuss in detail what I would do, if and when the dollar crashes.