Why Has the Dollar Rebounded - And When Will It Correct?

The dollar has continued to maintain strength relative to many foreign currencies since the collapse of U.S. financial institutions. During the summer of 2008, the dollar was trading at close to $1.60 to the Euro and now, on November 24, it trades at close to $1.25 to the Euro.

The rapid ascent of the dollar caught many traders off guard. The cascading fall of major U.S. financial institutions such as Fannie (FNM), Freddie (FRE), Lehman (LEHMQ.PK), and AIG (AIG) was the catalyst that ignited the dollar rally. Panic permeated the economic climate, prompting many financial institutions and main street businesses to question the soundness of the global banking system. Panic stricken investors pulled their money out of their risk infested banks and found calmer waters by anchoring their money in U.S. treasury bonds. With so many foreign investors purchasing U.S. treasuries, the demand for dollars grew to the point we are at today, $1.25 to the Euro.

The strength of the dollar is the result of panic and what is called an event risk. When the event risk subsides and normalcy returns to global markets, the dollar will revert to the secular bear pattern of the past two years.

There is little fundamental reason for the dollar to maintain the strength through this event risk. The dollar should be in worse shape after the event risk than before it due to the massive deficit spending and the expansion of our federal debt.

Moreover, this crisis comes at an inopportune time, when our country will be facing larger and larger structural deficits due to the Medicare and associated retirement costs of the Baby Boomers. I would expect normalcy to start returning in 2009. probably around the early spring.

A catalyst to drop the dollar value might come from the recent announcement that China will spend $586 billion dollars to stimulate their slowing economy, which will most likely cause them to sell U.S. treasuries. This action should put downward pressure on the dollar.

Disclosure: no positions

Comments

[definitions:]

china's stimulus package should be using their cash reserves..
they have just announce that they are prepare to buy more US treasuries..FOR NOW...
that said, i too, am short the dollar..via etfs udn, tbt

2008 Nov 24 04:26 AM

[trw88:]

Who is this author? Pretty lean argument. Why is the dollar considered a "safe haven"? Nothing about relative strength of foreign economies, or relative interest rates which favors the USD. For the record, foreign finacial insitutions are in just as bad a condition and their Central banks are playing catch up easing rates and have further to go. For example, Switzerland had a surprise 1% easing just announced. I think the dollar goes higher for the short term.

2008 Nov 24 07:29 AM

[willynill:]

trw88 is correct: foreign financial institutions (and entire foreign economies) are having big problems. Unless you think that those economies will recover faster than the U.S. economy, you should not short the dollar.

2008 Nov 24 08:50 AM

[xsuddensam:]

The answer is quite simple; the dollar has been propped up, in part, by driving down the price of gold and silver.

2008 Nov 24 08:53 AM

[sickofthehype:]

It's a global race to devalue currencies in tandem, and it's surely not the USD becoming desirable.

2008 Nov 24 10:27 AM

[mplaut:]

IMO the dollar value should not be seen in the context of other currencies but in the context of ALL financial markets. Over the past 2 months everything has been going down except the dollar (and the yen). When people are confident enough that there will be no general meltdown they will return to other investments and the dollar will fall, as everything else rises. (In any case it is hard to see why the dollar will be a better bet in the case of a general meltdown than anything else.)

2008 Nov 24 10:46 AM

[Smarty_Pants:]

The recent rise in the dollar will eventually reverse. In the meantime we have a short window of opportunity to diversify away from dollars to other assets which should do well when the dollar resumes its downward trend in the future.

This is a rare opportunity to reduce your exposure to the eventual fall in the dollar's value at bargain basement prices.

2008 Nov 24 11:02 AM

[Still Renting:]

Gold is up about $115 in a little over a week.

Just sayin'...

2008 Nov 24 01:41 PM

[proseadvocate:]

I agree that the Dollar is irrationally exhuberant. I can only attribute it to the fact that the world is awash in American citizens' money, which was sold out of foreign investments to offset the losses on US junk. Somebody needs to explore the repatriotization theory by telling us just how many of the US dollars out their are owned by Americans. They typically don't know what they're doing so therefore they sold the babies with the bathwater. Ergo foreign bonds are losing out to US bonds which are losing out, along with all stocks and commodities too. The obvious question is what's wrong with this picture?

2008 Nov 24 09:09 PM