The American economy has taken a real beating so far this century. The early 21st Century I’m sure will be remembered as being a time of upheaval and change, particularly for the United States. Before the Dollar, there was the British Pound. The Pound was once the world’s reserve currency backed up of course by gold, but more importantly by the British Empire. Who would have thought after surviving two World Wars the Pound would be usurped as the world’s reserve currency by the currency of the former British Colonies? Well, that’s exactly what happened.

The United States guaranteed that each Dollar could be traded for its current value in gold. This is important as America’s financial problems at present can be traced back to 1971 when Richard Nixon abolished the Dollar/Gold standard, turning the Dollar into a fiat currency backed by, well, the Federal Reserve. Now this is no longer the case (being backed by gold), the Federal Reserve can print as much money as they want, because they are no longer limited by the amount of gold available and therefore exchangeable for US Dollars. The problem with this is that printing more and more Dollars and putting them in circulation devalues the currency and WILL eventually lead to hyper-inflation. This can now be seen in the performance of the Dollar against other world currencies but, more importantly, in its performance against gold. Don’t be fooled by its recent Bullish performance, the Dollar will not make it out of this decade alive.

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So by now you’ve heard the unofficial results of the bank stress tests. Only ONE, that’s right, ONE bank out of the nineteen tested is in need of additional capital. SHOCKER!! I mean really, did anyone actually believe that the government would do more damage to the already-fragile banking system?

Last Friday, the government disclosed the measures that were used to test the banks. This Monday, the US markets opened lower. All of the talking heads will tell you that we opened lower because of the dangerous swine flu, but I find this to be a bit too convenient. Wag the Dog, anyone?

Let’s face it; the government stands to lose far more than any individual bank that could not pass the stress tests!! (I wonder which bank will take one for the team?). One thing is for certain, the Government is “all-in” with a portfolio heavily weighted in banks.

When was the last time you bought a stock and then hit the message boards talking about how BAD of a company it is? Didn’t think so!

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Optimism regarding stability around current levels encouraged buyers to come back into the market last week, bottom fishing various beaten down stocks. The major U.S indices closed up by over 10%, forming weekly bullish engulfing candlestick formations on various charts. Even though economic stress is still weighing on the economy, affecting different sectors, expectations of a brighter future in the distance are now sending investors back into stocks, trying to grab opportunities at discount prices. To date, analysts are still expecting to see more of a sluggish economy, an economy that will continue to contract until the end of this year and throughout the beginning of next. In addition, unemployment is expected to continue to rise from its current level of 6.1% during the next couple of months, making the current economic slowdown one of the longest and harshest ones since the 70’s.
A lot of important economic data came out last week, among them a GDP result showing that the U.S economy had contracted in the third quarter by 0.3% and a rate cut in the U.S, which brought its fund rate down to 2002’s levels of only 1%. To date the U.S is yielding investors one of the lowest interests among financial investments and according to the Fed, additional rate cuts might not be so far off. With interest differentials of over 4% between the U.S and other economies, traders have become puzzled why the U.S Dollar is gaining strength.

Can the Dollar be rising while stock markets are gaining strength?
When learning basic economics, every novice learns apart from the basics of supply & demand and the Keynes theory, that interest rates affect the different financial securities in various ways. Rising interest rates are good for a currency as it attracts investments due to high yielding interest, but it is bad for the stock market as a rising central rate affects rates within the economy, offering better alternative’s for investors than a risky stock market, while depressing demand as borrowers end up paying higher returns.
Under normal market conditions we would expect to see that as the Fed plays with its rates to control healthy economic growth, dollar and stocks trade in opposite directions. As one goes up for a period of time the other goes down (within their major trends).
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