Our negativity (scenario #1) in a nutshell, via feedback loops

Quotable

“We live immersed in narrative, recounting and reassessing the meaning of our past actions, anticipating the outcome of our future projects, situating ourselves at the intersection of several stories not yet completed.”

                           Peter Brooks

FX Trading – Our negativity (scenario #1) in a nutshell, via feedback loops

Feedback Loops: Central to a full understanding of dissipative systems, and especially those in symbiotic relationships, is the concept of system feedback (Stear, 1987). Complex systems with feedback loops that allow for self-renewal are called autopoietic structures. One example of a simple, self-organizing system is a whirlpool. Another example is the red spot on the planet Jupiter. Other systems, such as the human body, can be extremely complex (Briggs and Peat, 1989).

Our rising dollar forecast is based on a very negative view of the future based on what we believe are logical feedback loops, which in turn could trigger a nasty downward self-reinforcing spiral:

1) US Consumer: Real, or perceived, threat of double-dip recession thanks to private deleveraging, thanks to lack of opportunities to create wealth in the private sector in large swaths of the world’s economy, because of government denying the market process, leading to wealth destruction, leading to private deleveraging…
2) China Disappointment: Self-reinforcing downward sentiment, from #1 above, pushing stocks lower (everywhere), thus endangering what remains of real collateral values in large degree dependent on Chinese growth which is in large part dependent upon US consumer leveraging; a tight and potentially nasty feedback loop that could pull in another self-reinforcing element—trade tensions (see Michael Pettis commentary in the Financial Times today).
3) German Disappointment: Rising systemic risk within the eurozone, driven by the realization Germany’s export game cannot continue on track without someone out there to take them, reinforces the negative impact of severe domestic adjustment across the PIIGS, which in turn likely triggers sovereign default and emerging market contagion, transmitted by the European banking system doing all it can by draining outstanding loan credit to shore up balance sheets.
4) Thus, private deleveraging globally completely overwhelms government so-called stimulus programs.

Evidence:
1) US consumer credit falling
2) Monetary velocity in the tank
3) Desperation of QE2
4) Yield spreads in the eurozone rising
5) Chinese growth slowing
6) Japan deflation worsening

Upshot:
1) Stocks break big
2) Dollar rallies big
3) Commodities get hit big
4) Gold rallies on risk
5) Bonds, incredibly to some analyst, move higher in price as yields sink further

This is not a pretty picture. Thank goodness we have proved in the past we can be very wrong. That is why scenario #2 is in our hip pocket.