Tom at Neural Market Trends posed the question on how one would build a neural network model of the US Dollar. I added the following comment:

My answer is you can’t. I am dead serious here. There is no real precedent for this since it is a black swan type event. The only thing you could do is do a series of Monte Carlo simulations that walk the path of the dollar and see where you get.

And if that fails throw some dice and see where they end up.

Here is how I see things playing out from some of my past MonteCarlo simulations. Oil eases back slightly the market is squeezed, but the dollar keeps doing its mambo in a range. OR we have an oil super spike collapse of the equity markets and collapse of the dollar.

Right now the psychology is to move into commodities to avoid the dollar drop. I am easing slightly back from my 1.76 prediction, but not much. It really depends on oil.

As Jeff Macke in Fast Money said, “There is only one thing to invest in, oil. Everything else will get destroyed by it step by step.”

Tom replied as follows:

What kind of distribution did you use for your data to come up with this? A normal dist? You have to remember a BSE is an outlier way off in the “long tail” of a distribution.

The reason I asked this question in this post is that for all the gloom and doom of the USD, one day it will rebound and rally. The question is, where it would rebound from and what would be the inputs you’d use to give you signal.

What goes up must come down and what goes down will come up! How’s that for scientific?

My distribution curve is a secret sauce type of thing and hence I will not divulge how I come up with my walk. Though the walk will only get you so far, and as others have replied you could look at macro conditions, interest rates, etc, etc…

I said that the current behaviour of the USD is a black swan event because the drop of the USD is unprecedented. A black swan event is only a black swan event because one needs to broaden the scope of context to understand what could and might be happening.

I think the American Dollar is at the end of an epoch. I am not predicting that the world will search for a new currency. On the contrary I think the world will be pricing things in terms of baskets. Companies will attempt to maximize profit, while minimizing potential losses due to currencies. Thus no single currency will be the main actor.

If this is indeed the end of an epoch then the question becomes has there been a currency situation where an epoch ended? Indeed there has, namely the British Pound. If you go to the website Measuring Worth you will find the exchange rates of the British Pound to the USD from 1791 till now.

In 1791 one British Pound equalled 4.55 US Dollars. Today one British Pound equals 1.97 USD. Thus between 1791, and 2008 something happened. The big drop of the British Pound to the USD happened in years 1948 to 1950. What you should notice is that the drop was quite big and all of the sudden. Very similar to the current drop of the USD. Some of you historical buffs will remember around that time the gold standard was in question. Though I do not think it was the gold standard that caused the problem.

What caused the problems were the years 1939 to 1942 as Britain became bankrupt from fighting World War 2:

During the 1939–1942 period, the UK depleted much of its gold stock in purchases of munitions and weaponry on a “cash and carry” basis from the U.S. and other nations.[citation needed] This depletion of the UK’s reserve convinced Winston Churchill of the impracticality of returning to a pre-war style gold standard. John Maynard Keynes, who had argued against such a gold standard, became increasingly influential. Nevertheless, his theories were rejected in 1944 Bretton Woods Agreement, which established the IMF and an international gold standard based on convertibility of the various national currencies into a U.S. dollar that was in turn convertible into gold.

Does this sound familiar? What is bankrupting America right now? This is not a questioning of the decision behind the war on terror and war in Iraq. Remember that Britain did not have a choice on whether or not to fight in World War 2. What I am saying is that I think the Iraq war is bankrupting America and it is the straw that broke the camel’s back. Of course many will say, “hey it was the Fed and their cutting of interest rates.” Yes, exactly how the gold standard at the time caused a major disruption. BUT, the gold standard disruption was a sideline compared to the bankrupt Great Britain.

A little while back I made a prediction that the USD to Euro would drop to 1.76, and from having written this blog entry that looked at the bigger context I don’t think I will be wrong. Does this mean that the American economy will nose dive, and America will become bankrupt? No, not at all. If you look at the British economy it is very vibrant and alive.

What is different is that the British Pound is not a major currency, just like the USD will not be the major currency. Great Britain is a powerful force, but is not the dominate force, and that will happen to America as well.

But, and read me very carefully here. I am very bearish on the USD, but I am not bearish on the American economy. As has been seen in corporate earnings the weaker dollar is very good for the American manufacturing base. Many companies are looking very hard at relocating to the US for building products (eg BMW). This is good for America because America will move away from its financial tendencies and towards manufacturing. And this is good for America because average people will get good paying jobs and be able to live that American dream again.

So back to Tom’s comment:

What goes up must come down and what goes down will come up! How’s that for scientific?

I personally don’t believe for the near or medium term that the dollar will rebound. Maybe in 40 to 50 years sure, but not now, nor medium term.