Wednesday February 17, 2021 - 14:56:38 GMT
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US Dollar Scenario: What If the Unthinkable Becomes Thinkable?
In response to my article, The Dollar Blow Up Scenario, another well-respected professional trader and long-time Global-View member sent me the following. As you will see, he takes a different view.
He starts out by quoting this statement from The Dollar Blow Up Scenario
If they permit rates to rise, the interest payments could well be a huge budget item, maybe rivaling the military line item. This may seem unthinkable but it may become increasingly likely. As the Fed holds the lower end of the interest rate curve down, the back end will pop up in response to inflationary expectations.
Yield Curve Management (i.e. the whole curve) is coming so that will change this statement.
In addition, negative yields whilst the current scenario continues to exist (i.e. no cancellation of US government debt, etc) will eventually come about.
It is inevitable, partly because they cannot afford to pay higher rates and partly because higher rates will act as an additional drag on growth.
So, the FED cannot stop it from happening.
You only need to look to the rest of the world and Japan in particular for the scenario.
Actually, we are still in a deflationary age where inflation is evidenced in assets rather than headline rates.
I know there has been a lot of talk about inflation coming from the printing of QE but the reality is that it has not surfaced to any great degree (it has manifested more as a stop the huge deflationary decline via the printing presses) and we now have hard evidence that most of the $600 unemployment additional money (now $300) plus the $1200 original handout and now the $600 to which will be added $1400 soon has actually been saved and also invested in stock markets.
What If the Unthinkable Becomes Thinkable?
The end result is more likely to be as I have argued for years: Default, Forgiveness, Write Off AND Cancellation.
The US can at the stroke of a pen start this process without actually falling into the trap of default. The FED's balance sheet can be converted instantly into a zero bottom line by giving the treasuries it holds (as can all the cross holdings by various government departments) back to the Treasury which can then cancel the paper.
In other words,
The FED hands that paper over to the Treasury.
The Treasury balance sheet now shows on one side of the ledger....paper issued and on the other side..... paper invested
It is no different from a stock buyback.
They issued it and now with the FED s printing press (which in reality is the Treasury's printing press) they bought it back.
Voila at the stroke of a pen the deficit is halved, if not more, and the USD would actually not go into the tank but rally hard.
This scenario would take the world by storm and actually add to the deflationary scenario but it would unleash the levers of growth that are currently being held back due to the FED's policies.
To sum up
While this scenario would have seemed like science fiction in the past, as one trader wrote to me recently, “we have seen so many bizarre reactions… I don’t recall ever seeing quantitative easing on such a scale and stretching out for so long… that nothing can be ruled out.”
One point agreed upon in both scenarios is that the Fed cannot afford to see long term rates rise too far as higher interest rate costs would blow out the already massive US budget deficit. The real challenge will come if inflationary pressures build. In this regard, the jury is out as economists, as well as the two Global-View members who sent me their scenarios, have made arguments on both sides.
For traders, whatever creates volatility is good for trading. As I have been noting, here is is how to take advantage of it.
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