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Could the US Dollar Carry Trade Crash Stocks?

For 30+ years, Western countries have been papering over the decline in living standards by issuing debt. In its simplest rendering, sovereign nations spent more than they could collect in taxes, so they issued debt (borrowed money) to fund their various welfare schemes.

This was usually sold as a “temporary” issue. But as politicians have shown us time and again, overspending is never a temporary issue. This is compounded by the fact that the political process largely consists of promising various social spending programs/ entitlements to incentivize voters.

In the US today, a whopping 47% of American households receive some kind of Government benefit. This type of social spending is not temporary… this is endemic.

The US is not alone… Most major Western nations are completely bankrupt due to excessive social spending. And ALL of this spending has been fueled by bonds.

This is why Central Banks have done everything they can to stop any and all defaults from occurring in the sovereign bonds space. Indeed, when you consider the bond bubble everything Central Banks have done begins to make sense.

1.     Central banks cut interest rates to make these gargantuan debts more serviceable.

2.     Central banks want/target inflation because it makes the debts more serviceable and puts off the inevitable debt restructuring.

3.     Central banks are terrified of debt deflation (Fed Chair Janet Yellen herself admitted that oil’s recent deflation was economically positive) because it would burst the bond bubble and bankrupt sovereign nations.

So how will all of this play out?

The first real sign of trouble has already emerged. That sign pertains to the US Dollar.

Globally, the world is awash in borrowed money… most of it in US Dollars. The US Dollar carry trade is north of $9 trillion… literally than the economies of Germany and Japan COMBINED.

When you BORROW in US Dollars you are effectively SHORTING the US Dollar. So when the US Dollar rallies… you have to cover your SHORT or you blow up.

And the US Dollar has been rallying… HARD. Indeed, the move that began in July is already on par in scope with that which occurred during the 2008 meltdown:

This first wave imploded the price of Oil, numerous other commodities, and several emerging markets equities, most notably in Russia and Brazil.

However, the US markets are not immune to the move.

Indeed, as ZH noted earlier this week, 87% of companies have guided below consensus expectations for next quarter. The stronger US Dollar is hurting profits… which are the single biggest driver of stock prices.

What happened the last time that stocks were strongly disconnected from reality… and the US Dollar began to rally hard?

Be prepared.

 

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