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Why this Financial Crisis is not Over: Assesing Debt, Dollars, Gold, and Greed

Posted on February 12, 2009 by Adam

The stock market has been teetering at a pivotal level over the last week. Wave after wave of hopeful buyers entered the market, only to see their efforts thwarted by the onslaught of the weakening economy.

The financial crisis is far from over - the panic that ensued in late 2008 may be over, but we have just begun the long and painful unwinding of debt that must take place before the economy can heal itself. I have talked in the past about how we got here, and the conditions leading up to the precipitous decline we have seen thus far, but I want to take some time to focus on the damage yet to come, and what we will need to see happen before it is fixed.

All stories have a beginning. The story of the new millennium economic crisis begins with debt. The years leading up to 2007 unfolded into a vicious spiral of lending and debt. Debt, in and of itself, is not a bad thing. If money is the blood of our economy, then debt is the heart, essential for keeping a free market society working. Without debt, businesses could not raise capital, students could not get loans for school, and families could not purchase houses.

Over the years, however, debt has reached enormous levels - levels that have not been seen since the great depression. Both consumers and institutions alike borrowed and borrowed to their hearts’ content. Debt in the United States numbers in the tens of trillions of dollars!

But what did we do with that money? Simply, we invested it. The money was invested in assets like real estate, stocks, and commodities. When real estate prices started to decline, suddenly we could not afford to repay all our debts. In order to repay our debts, we have begun to liquidate our assets, which has driven prices down universally. But since our assets are worth less than we paid for them, we still don’t have enough money to repay the principal on the money we borrowed, never mind the interest!

That’s where dollars come into play. With all this debt to repay, and not enough money to do it, dollars are in short supply these days. Demand has skyrocketed for the US Dollar, simply because so much debt is still unpaid, and the Treasury can’t print money fast enough to keep up!

Rising demand for the US Dollar and short supply have sent the greenback into a sharp bull market, which has only exacerbated our debt problems, since our debts are now worth more than before.

As long as the dollar continues to skyrocket, our economic woes will persist. Today was a discouraging sign for me for a number of reasons. For one, the S&P 500 took a turn for the worse, turning lower from support, putting it on a sell signal. In a parallel move, the dollar broke out of a month long consolidation pattern to the upside, indicating that debt still has a long way to unwind.

Until the dollar starts to head lower in earnest, and gold stays below $1000/Oz., I cannot get bullish on the long term outlook for the stock market. As long as the dollar is strong, the economy is weak.

Ultimately, the dollar will head lower when demand wanes. The relentless printing presses at the Treasury will finally see an effect - an effect much more severe than most politicians have anticipated. When the dollar does break down, I want to be in that trade. But it’s not ready yet. I don’t know when this financial crisis will end.

Today we got a sobering reaffirmation of that fact. Personally, I hope it ends soon, and I’ll be watching the dollar to know when it does.

The dollar broke out to the upside from a monthlong consolidation pattern, indicating that debt is not done unwinding.

Happy Trading!