By one measure, the Dow Industrials Index is now at its second-most ‘overbought’ level since 1980. The measure I’m referring to is the 14-day RSI (Relative Strength Index), a short-term momentum oscillator shown in the bottom section of the following Dow chart.

Being the most something-or-other (the most overbought/oversold, optimistic/pessimistic, etc.) since a distant past time often isn’t as important as it sounds. For instance, the only time since 1980 that the Dow’s daily RSI(14) was as high as it is today was in November of 1996 (interestingly, almost exactly 20 years ago), but nothing dramatic happened during the days, weeks or months that followed the November-1996 momentum extreme.

As illustrated below, a pullback to the 50-day moving average (MA) got underway within a few days of the momentum extreme, after which the Dow resumed its long-term advance. There was a more significant short-term pullback (to the 200-day MA) a few months later and an intermediate-term correction a few months after that (more than 8 months after the momentum extreme), but the bull market continued for another 3 years.

A short-term momentum extreme occurred at the price peak that was followed by the October-1987 stock market crash, but it is a lot more common for such extremes to be followed by nothing more serious than a routine multi-week correction. With measures of market breadth pointing to a 6-12 month extension of the bull market we probably won’t get anything more bearish than a routine multi-week correction within the next couple of months, although I admit that the near-vertical rally since the Presidential Election has me ‘on edge’.

Blackham Resources (BLK.AX), a junior gold producer that has just begun to ramp-up production at a newly-commissioned mine in Western Australia, reported something interesting earlier this week. Having forward-sold about half of next year’s expected gold production a few months ago when the gold price was near its highs for the year, the company recently took advantage of gold’s price decline by closing-out the bulk of its forward sales. It did so by purchasing gold and delivering it into the forward sales contracts, thus realising a cash profit of A$6.3M.

In other words, having sold high during May-September, BLK’s management turned around and bought low over the past couple of weeks. Sell high, buy low. Sounds like a good strategy to me. More gold producers should try it.

The euro-zone appears to be on target for another banking crisis during 2017. Also, the stage is set for political upheaval in some European countries, a general worsening of economic conditions throughout Europe and widening of the already-large gaps between the performances of the relatively-strong and relatively-weak European economies. It’s a virtual certainty that as was the case in reaction to earlier crises/recessions, blame for the bad situation will wrongly be heaped on Europe’s experiment with a common currency.

The idea that economically and/or politically disparate countries can’t use a common currency without sowing the seeds for major problems is just plain silly. It is loosely based on the fallacy that economic problems can be solved by currency depreciation. According to this line of thinking, countries such as Italy and Greece could recover if only they were using a currency that they could devalue at will. (Note: The destructiveness of the currency devaluation ‘solution’ was covered in a previous blog post.)

The fact is that economically and politically disparate countries throughout the world successfully used a common currency for centuries up to quite recently (in the grand scheme of things). The currency was called gold.

The problem isn’t the euro; it’s the European Central Bank (ECB). To put it another way, the problem isn’t that a bunch of different countries are using a common currency; it’s that a central planning agency is attempting to impose the same monetary policy across a bunch of different countries.

A central planning agency imposing monetary policy within a single country is bad enough, in that it generates false price signals, foments investment bubbles that inevitably end painfully, and reduces the rate of long-term economic progress. The Federal Reserve, for example, has wreaked havoc in the US over the past 15 years, first setting the scene for the collapse of 2007-2009 and then both getting in the way of a genuine recovery and setting the scene for the next collapse. However, when monetary policy (the combination of interest-rate and money-supply manipulations) is implemented across several economically-diverse countries, the resulting imbalances grow and become troublesome more quickly. That’s why Europe is destined to suffer a monetary collapse well ahead of the US.

It should be kept in mind that money is supposed to be neutral — a medium of exchange and a yardstick, not a tool for economic manipulation. It is inherently no more problematic for totally disparate countries to use a common currency than it is for totally disparate countries to use common measures of length or weight. On the contrary, a common currency makes international trading and investing more efficient. In particular, eliminating foreign-exchange commissions, hedging costs and the losses that are incurred due to unpredictable exchange-rate fluctuations would free-up resources that could be put to more productive uses.

In conclusion, the problem is the central planning of money and interest rates, not the fact that different countries use the same money. It’s a problem that exists everywhere; it’s just that it is more obvious in the euro-zone.

This post is an excerpt from a recent TSI commentary.

Every central bank in the world, including the US Federal Reserve, now wants a weaker US$, which proves that central banks can be overwhelmed by market forces even when they are united in their goals.

Central banks outside the US want a weaker US$ due to the long-term consequences of the actions that they themselves took many years ago to strengthen the US$. To put it another way, they now want to strengthen their own currencies against the US$ because their economies are suffering from the inevitable ill-effects of the currency-depreciation policies implemented at an earlier time. As discussed in the past, currency depreciation/devaluation is always counter-productive because it “engages all the hidden forces of economic law on the side of destruction, and it does so in a manner that not one man in a million will be able to diagnose.” It is still a very popular policy, though, because at a superficial level — the level at which most economists and all central bankers operate — it seems practical.

Unfortunately for the central banks that are now trying to prop-up their currencies relative to the US$, a central bank’s ability to weaken its currency is much greater than its ability to bring about currency strength. The reason is that weakening a currency can usually be achieved by increasing its supply, and if there is one thing that central banks are good at it’s creating money out of nothing. Actually, creating money out of nothing, and, in the process, engaging all the hidden forces of economic law on the side of destruction, is the ONLY thing they are good at.

The problem they are now facing is that once confidence in the currency has been lost, bringing about currency strength or at least a semblance of stability will generally require either a very long period of politically-unpopular monetary prudence or a deflationary depression. There is no quick-and-easy way to obtain the desired result.

The crux of the matter is that there is very little that central banks outside the US can now do in the short-term to stop the US$ from rising. The best they can do is to NOT inflate. Other than that, they should simply avoid the temptation to ‘do something’ and instead just wait for the current trends to exhaust themselves.

The US central bank also wants a weaker US$. This is because the senior members of the Fed operate at the same superficial level as their counterparts throughout the world. They see the direct, short-term positives that a weaker currency would bring to some parts of the economy, but are incapable of seeing the broader, longer-term and indirect negatives.

The difference is that the Fed actually has the power to create short-term weakness in the US$. It could, for example, surprise the world by not hiking its targeted interest rate in December. That would knock the Dollar Index down by at least a couple of points. To build on the decline it could then start emphasising the sluggishness of US industrial production and dropping hints that another QE program is coming.

Doing so would, however, be a reckless course of action even by Keynesian standards. The US dollar’s upward trend would be over, but at the cost of a total loss of credibility on the part of the Fed and breathtaking instability in the financial markets.

Once lost, confidence is difficult for a central bank to regain. The Fed is therefore now backed into a corner where for the sake of appearances it will have to take small steps in the direction of tighter monetary policy, even though it would prefer a weaker US$.