Why Does the Dollar Go Down When the Stock Market Goes Up?

Or, asked another way, why does the stock market get stronger when the dollar gets weaker? This isn't always the case, though it has been true, more or less, for the last ten years.

The short answer is stocks are valued in dollars, so, all else being equal, when the buying power of the dollar drops, the price of stocks rises. It's basic inflation. But that's not the whole story.

For the last ten years the stock market has moved practically in lockstep with the inverse movement of the dollar. Look at the following chart. The orange line is the movement of the U.S. stock market. The green line is the movement of the U.S. dollar.  Note the inverse symmetry since about 2003, and especially since 2008.

This inverse relationship suggests that increases in the stock market lately have not been due to economic growth, but due to the government's money policy. When the dollar gets weaker that often means inflation, i.e. money printing, is going on. When QE3 (more money printing) was recently announced, the stock market rallied and the dollar got crushed. Why? Because the markets realize that though the new money will likely increase stock prices, it will also debase the dollar. So in the end, these stock gains could theoretically just be a wash. That is, if the stock market increases 20% in value and the dollar falls 20% in value, the resulting profit is zero. This is assuming we are buying imports. And since most things we buy these days are manufactured outside the U.S., that is the case.

Sometimes the stock market and the dollar go up together. This suggests high confidence in our economy, because not only is the price of stocks going up, the means to buy them and what you get back when you sell them--dollars--are increasing as well. This is what happened in the late 1990s. Real wealth was being transferred to Americans who held stocks and dollars.

Alas, this is not the case now. It's just a lot of money moving around from market to market--a kind of financial Whack-a-Mole, where you hope you're not the mole that gets whacked.