Photo by Rene Böhmer on Unsplash

Amidst a backdrop of raging consumer price inflation something strange and unexpected is going on. The U.S. dollar has become more valuable. Not against goods and services. But against foreign currencies.

For example, the U.S. dollar index, which is a measure of the value of the dollar relative to a basket of foreign currencies, recently crossed the 105 level. This marks its highest level since December 2002. Not since tech stocks were in full meltdown in 2002 has the dollar been so strong.

Without question, the dollar had quite a run. The dollar index increased by over 6 percent in 2021. So far in 2022, it has already gained over 7 percent. And, for the time being, despite shortsighted dollar weaponization policies, the dollar is preserving its reserve currency status.

This week, the dollar index did retreat slightly…at market close Thursday (May 19) it stood at 102.91. Maybe the dollar has peaked. Or maybe this is just a period of consolidation before its springs upward.

From a historical perspective, the dollar could go much, much higher. In the mid-1980s, for instance, the dollar index hit 164. Of course, the world was much different back then. The euro didn’t even exist.

From our perspective, it seems unlikely the dollar index could hit its old high from nearly 40 years ago. But it does seem likely the dollar could hit parity with the euro for the first time in 20 years.

Slow growth and high inflation in Europe could continue to be a drag on the euro. In addition, the Russia-Ukraine war, and the resulting supply chain disruptions to natural gas imports in Europe, point to a weaker euro ahead.

So what are we left with?

Somehow, with all its faults and foibles, the dollar is perceived to be an interim safe-haven asset. Somehow, with its 75 basis points in rate hikes this year, the Federal Reserve is perceived as being hawkish on inflation. Somehow the dollar, and dollar-based investments, have become attractive to foreign investors.

What’s going on…
 

Insufficient Explanation

You’ve likely heard the well-worn metaphors. The dollar’s the cleanest shirt in the dirty laundry basket of fiat money. The dollar’s the best house in a bad neighborhood.

Does this really explain what’s going on?

Maybe. At least for now, it offers a partial and insufficient explanation.

As noted above, the euro is haggard. But it’s not just the euro…

In Japan, the situation is quite different. Inflation is just 1.2 percent – compared to 8.3 percent in the U.S. Following the simultaneous meltdown of the Japanese NIKKEI and the Japanese real estate market in 1989 the Bank of Japan (BOJ) has tried just about everything to compel inflation higher.

The BOJ has tried policies of unlimited bond-buying. It has also pumped massive amounts of printing press money into Japanese stocks via exchange-traded funds. It has splattered the countryside with concrete under the guise of public works spending.

Through its efforts, the central bank has driven Japan’s debt to GDP ratio to over 250 percent. Still, inflation has remained elusive. Thus since the BOJ wants higher inflation, and is unlikely to hike interest rates like its cohorts at the Fed, the Japanese yen is staying comparatively weak against the dollar.

That’s the popular story, at least. The rationale, no doubt, is rather suspect.

At the same time, Beijing’s control freak zero-COVID policies have transformed the Chinese yuan into panda turds. For these reasons and many more, the U.S. dollar is in high demand.

The whole thing seems rather farcical. On a relative basis, the dollar may be strong. But it’s still doomed…just like all fiat currencies.

So, what’s up with gold?

What’s Up With Gold?

U.S.-based gold investors may be frustrated by the dollar’s strength. With consumer price inflation raging at a 40-year high, shouldn’t the price of gold be shooting to the moon?

Simple logic says yes. Gold is a venerable hedge against inflation. Consumer price inflation is raging out of control. Therefore, gold, as priced in dollars, should be adjusted upward.

But that’s not what’s happening. At least not yet.

After hitting $2,039 per ounce in early March, the price of gold, in dollar terms, is down 9.7 percent. If you’re sitting on a pile of cash, now’s certainly a good time to trade some of it in for gold bullion coins – and silver too.

Remember, gold is for long-term wealth preservation and not for short-term speculation. Owning gold sets you free from the destructive money debasement policies of central bankers and centrally planned governments. And owning gold will be especially important when the dollar turns later this year – if it didn’t already turn this week.

You see, the U.S. economy is entering a recession. In fact, it may already be in one. U.S. GDP shrank by 1.4 percent during the first quarter of 2022. The stock market, sensing the weakness, is in full meltdown.

With this backdrop, Fed Chair Jay Powell is staring down a difficult choice. Continue to hike interest rates in the face of a recession? Or reverse course, support financial markets, and let inflation run?

What will he do? We anticipate he’ll do both…

The Fed will likely hike rates another 50 basis points following the June FOMC meeting. It needs to put on a show of strength to restore any semblance of credibility after booking it so hard with its “inflation is transitory” shtick.

By mid-summer, however, it will be clear the U.S. economy is in a recession. The Fed will then pause its rate hikes, and then start cutting rates.

Under this scenario, the dollar will turn from sirloin to bottom round. This is when gold will really shine.

If you recall, the last time the dollar was this strong – back in 2002 – an ounce of gold cost about $320. Over the next nine years, an ounce of gold, priced in dollars, increased by 490 percent to about $1,900.

Given the monetary shenanigans and outright policies of extreme dollar destruction that have occurred over the last 14 years, the relative increase in gold’s price in dollar terms should dwarf the move that occurred during the first decade of the 21st century.