A reverse stock market crash: The dollar hasn’t done this since 1973

Past performance isn’t a reliable indicator of future results.

In Turkey, the main stock index has surged by more than 1,000% during the same period, nearly six times as much as the S&P 500. And in Argentina, it's up by nearly 8,000%.

At first glance, that sounds like a trader's dream, but those record gains tell a different story. As this chart shows, the Turkish lira has lost roughly 85% of its value against the US dollar over the past 5 years, and the Argentine peso has fallen by more than 95%. So for these investors, the wealth they see on paper is merely an illusion as their purchasing power erodes. The rallies happened because their currencies collapsed.

This is what we call a reverse stock market crash

And while that might sound like a distant emerging market problem, the early signs of the same dynamic are appearing in the world’s reserve currency, the US dollar.

The US dollar has just recorded its worst performance since 1973, falling more than 10% this year, and major institutions, including Morgan Stanley, expect the dollar weakness to continue. Now, at first glance, that might sound far-fetched. Yes, the US dollar index has weakened this year. But when we zoom out to the last 15 years, we can see that the dollar is still trending higher. In fact, today the dollar sits around the same level it did a decade ago.

So it means the dollar hasn't lost much of its value, right?

Well, it depends largely on what you measure it against. See, the dollar index measures the dollar against other currencies like the euro, British pound, and Japanese yen. But if those currencies are all losing value, too, the index can stay flat even while everything else gets more expensive.

To really see what's happening, you have to measure the dollar against something that actually holds its value, like gold.

This chart, for example, shows gold priced in US dollars. And as we can see, it does not look very stable. Back in 2010, $1,000 could buy 1 ounce of gold. Today, it barely buys a quarter of that.

We can see a similar pattern in housing prices

In 2011, the average US home cost around $180,000. Today, it's more than $430,000, over twice as expensive for a similar house.

When a currency loses value, it takes more of that currency to buy the same goods and assets. That's what inflation really is, the mirror image of currency weakening.

In fact, this decline in currency purchasing power has played a major role in shaping stock market performance, too. Since 1980, the S&P 500 has returned more than 6,000% for its investors. But once we adjust those returns for inflation, the real return drops to just around 1,000%—nearly six times lower. So much of what looks like market growth is actually the reflection of a weaker dollar over time, a slow-motion version of a reverse market crash.

But the question now is whether this trend could accelerate as it did in countries like Turkey and Argentina, where inflation and weak currency eventually overpowered real market gains.

To answer that, we need to look at something called the money supply, or the total value of US dollars circulating in the economy. Money supply increase is what causes the price of nearly everything to rise over time.

When we overlay the S&P 500 on top, we can see that relationship with the stock market as well. Over the long run, as more money circulates, stock prices generally rise. That's because companies can pass on higher costs to consumers, their revenues grow, and so do their share prices. In other words, stocks act as partial protection against inflation.

However, this relationship isn't perfect. There are periods when the money supply grows while markets decline. This chart shows the relationship between the S&P 500 and the money supply more clearly. When the line is rising, the stock market is growing faster than money supply. When it's falling, money is expanding faster than market wealth.

You can see this ratio dropped during the 2001 and 2008 recessions, when stock markets crashed even as money supply kept rising. But more importantly, it's what happened between the 1970s and 1980s, a period when this ratio fell for more than a decade.

When we look at what the actual stock market did in the 1980s, it was making new all-time highs. But once we adjusted for the surge in money supply, the stock market performance actually still went down. So in real terms, the market wasn't creating much new wealth at all. That's a perfect example of a reverse stock market crash.

So what caused it back then?

The US was hit by runaway inflation and an oil shock that sent energy prices soaring. To keep the economy afloat, the government printed more money, which only made inflation worse. It wasn't until inflation was finally brought under control that real market growth returned.

Today, this doesn't seem to be the case. The S&P 500 relative to money supply is now rising to its highest level since the late 1990s. That means investors are for now creating genuine real wealth, not just inflation-driven gains, much like what we saw during the economic boom of the 1990s.

Inflation also remains contained, far from the runaway levels seen during the 1970s. So if inflation remains under control and the economy stays resilient, the stock market could continue rising faster than the expansion of money supply, creating genuine real wealth for investors.

However, if inflation begins to accelerate, driven by more rapid monetary expansion or external shocks, and the economy starts to weaken, the story could shift quickly. In that scenario, the ratio of the S&P 500 to money supply could drop sharply, signaling a market downturn or even a reverse stock market crash.

At Capital.com, we'll keep tracking how inflation, liquidity, and money supply interact to shape real market wealth and what it all means for investors. Explore more insights in our Educational Hub.

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