Another day, another dollar (for some)

Author: Value Investor  Date: 2020/04/20

Well, another tumultuous trading day for equities is over. This time with the market ending on the downside. Actually, taking into account the recent volatility, it could have been much worse. There was a barrage of more bad news from most of the fronts, but not about so much about the coronavirus, for a change. The market’s reaction (moving lower) is at least in line with what could be expected in the current environment.

They say that in a recession the stock market starts moving higher about four month before the start of a recovery. In our case, however, it bounced up around 30% from its lows even though there is no expectation of any meaningful recovery this year.

There was a remarkable selloff in oil today, which is heading lower and lower with no bottom in sight. By the way, one respected investor pointed out in an interview on CNBC today, that the last time oil was heading to its lows and Amazon to its highs was in 1999. We all know what happened after that. For him this is a strong sell signal. By the way, he called Amazon, Costco, and some other stocks as “misery stocks”. I think what he meant is that there is a group of stocks which are benefiting from the overall misery situation most people have found themselves in. His prediction, though, was that those stock will not be high-flyers for long and are doomed to join the crowd of other stocks soon.

Financial markets are interconnected, and what happens in one of them inevitably will be reflected somehow in the other. This happens primarily because all markets react to the same changes in the economy, albeit each in its own manner. The oil is cheap because of a drop in demand; the demand dropped because the global economy needs much less oil when three quarters of the world population are at different modifications of “stay-at-home” orders. But these are obvious things that you know even better than me.

What I wanted to mention in connection with global markets, though, is the following. We live in the global economy and the USA benefited handsomely from the globalization. Not the least because of the US dollar, which is a de-facto world currency. The demand for dollars grows with the growth of the global economy. US Treasury just issues IOYs (“I owe you”) in the form of dollars and the USA buys physical goos from other countries for them. It is called “seigniorage” - look it up.

As demand for dollars grows, there is no need to worry about the ability to satisfy these IOYs. This a source of enormous wealth for the country that issues such IOYs. What we are witnessing right now is a once-in-a-generation occurrence of a global recession. This means that the amount of dollars circulating outside the USA (either as banknotes or bank accounts, or their derivatives) is decreasing dramatically. The inevitable effect of this will a rush to get rid of the excess dollars. This will be what I call a negative seigniorage: the US would have to take all these dollars back in exchange for something of value in return. That would amount to the need in a short period of time to pay on the debt (IOYs) accumulated over previous decades. So watch for signs of dollar weakness as a harbinger of much worse things to come.