Addition and Subtraction

As many in the currency already know, a strong currency and a weak currency benefit the local economy in different ways. A strong currency can combat inflation while a weak currency can spur exports. Since 2002, the world has mainly benefited as the US Dollar has declined by almost 45%, using the Dollar Index (DXY), taking their currency gains and plowing them back into their own markets or other markets globally. This benefit mainly applies to those countries that "peg" their own currency to that of the dollar - mainly the middle east, China, Singapore and others. In addition, many countries have openly intervened to keep their currency from being too strong - essentially selling their currency high and buying the dollar low. This has created imbalances globally and what I call a "dollar bubble."

Essentially what is the dollar bubble? It is a bubble of investment that has benefited from the one way trade in the US dollar over the past 6 years. The likes of Brazil have seen major inflows into their economy as the Real has appreciated dramatically vs the good old greenback. Sure, there was some very interesting and supportive reasons to buy Brazil: high overnight investment rates, rising stock and local financial markets and stability politically. This has taken the Bovespa from the 18000 level a few years ago towards 70000 recently. Interestingly, when the USD was on fire to the upside through the late 90's into this decade, investment flows took the Nasdaq to 5000 (along with many other factors but the dollar was involved). A few months after hitting that 70000 level, the Bovespa is now cracking and guess what is occurring right at the same time - the dollar is stabilizing.

Another economy that has benefited from this one way trade has been China. In my opinion, if you take away the dollar peg, China is not growing at 9%, it is growing at 5% at most. The Yuan has fallen with the dollar over the last few years making their goods the cheapest on the planet by far sending major amounts of dollars and currency into the Chinese economy, leading to massive amounts of demand for infrastructure and commodities, sending crude prices sky high and global grain prices to the moon. The Shanghai comp rallied tremendously and then started to decline as the Yuan appreciated versus the dollar - albeit to a limited extent. Now the economy is slowing as well.

My point here is simple. These two economies, along with likes of Dubai and other mid eastern nations pegged to the USD, have benefited artificially from a weak dollar. What happens then if the dollar rallies like I think we are on the verge of? What happens if the Euro collapses through 1.50 and crude breaks 120? The great unwind occurs. What is the great unwind? the selling that is everything commodity or inverse to the dollar. I think the potential for a dollar rally is growing by the day and once the ECB flinches, and admits that they probably should have not hiked rates a few months ago (they are now tight by my calculations by 40bps), the Euro will be toast. And the one way trade....will be over.