Financial Death Spiral update

I've seen headlines that make me feel better than "Day of reckoning looms for the U.S. dollar":

The U.S. dollar's day of reckoning may be inching closer as its status as a safe-haven currency fades with every uptick in stocks and commodities and its potential risks - debt and inflation - are brought under a harsher spotlight.

Ashraf Laidi, chief market strategist at CMC Markets, said Wednesday a "serious case of dollar damage" was underway...

Whether it is or isn't, the sunny morning before a 4-day holiday weekend seems to be a fine time to just make a little noise about a few things that probably would not qualify for posts on their own.

First up, the Three Metrics*: gold, oil, dollar index. As long-time readers know, I have three personal "danger" metrics that I watch in full expectation that all three of them must be breached before financial Armageddon arrives. They are gold above the 1980 high of $850, oil over $90 a barrel, and the dollar under 80 on the NDX index. The last one is, IMO, the most important for reasons I'll explain. All three have only gone "bad" together once, not coincidentally it preceded last fall's expensively-avoided almost-meltdown by mere weeks.

As of this morning, gold is ~950 and on something of a tear, oil is safely below danger (~$60), and the dollar is getting close to 80 again, at 81 and change. So currently we are officially 2/3 out of danger, about to be 2/3 in danger. Or something.

OK, so with that said, back to the above article. A case of serious dollar damage is underway, but perhaps not for the reasons mentioned in the article. I've mentioned already that the government is going to have to borrow or print a couple of trillion dollars just for this year's operations, a number like 5 times bigger than the highest deficit ever. That alone, even if possible to borrow**, would seriously weaken the dollar.

But perhaps more important is the artificial effect the current bout of deleveraging has had on the dollar, a fact that (to be blunt) I never saw coming. As credit markets imploded last year, people, states, and companies found themselves unable to borrow. So in order to repay their existing debts, to bring down leverage, and in some cases to survive, they needed what? Cash. US dollars, and lots of them. The Fed and Treasury provided plenty of it, trillions of dollars' worth, but the need for cash during the worst of the crunch artificially strengthened the dollar, taking it from the edge of the abyss below 80 back up to ~88. The dollar was strengthened not by a "flight to quality" so much as by the fact that real dollars were needed and were suddenly in short supply. As the crunch part moves behind us, that acute need for cash moves behind us as well, and the artificial strength of the dollar moves behind us. Thus the current move from ~88 back down to the danger levels of last summer.

The credit crunch portion of the current financial crisis is over, or nearly over. We have dedicated by some estimates $10 trillion dollars to fight it. The stock market has been halved. Two of the Big Three automakers are bankrupt. The government owns the largest insurer in the world. The two largest mortgage lenders are insolvent and hemorrhaging money, surviving only via quarterly cash injections measuring in the billions. Housing prices are still falling at record rates in every major market. Unemployment is the highest in a generation and the unemployment rolls now support a record 7 million workers. State and local governments have made the easy*** budget cuts and are preparing for more in the face of a growing tax revolt.

This is not the bottom. We have just completed the first round of a bout scheduled for twelve.

Round 2 begins when the 80 level is taken out again.

* I used to work for an insurance company owned by the Swiss, who would invariably pronounce that word "matrix." It fit them, somehow.

** the jury is still out on that. I am certain we are going to see some serious fireworks this year at Treasury auctions.

*** though they have been real cuts, not like federal "cuts" which invariably end at higher level than where they were cut from.