If the U.S. Is in a Financial Crisis, Why Is the Dollar Rallying? 15 comments
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The global financial system is in a state of bedlam – just ask anyone whose 401k had WM, BSC, LEH, AIG, GM, or Citi (C) in it. And then there is the US, which has run historically large current account, trade and budget deficits over the last decade. One would think that the US with an estimated 2007 current account deficit of 731 billion, a trade deficit this year of about 700 billion and perhaps the first ever 1 trillion dollar government deficit next year, should be facing a run on its currency in the wake of this credit crunch. But in reality, quite the opposite is happening.
Why?
Despite all of the fundamental problems with the US dollar, people around the world still want to hold greenbacks. Why? First, and in my opinion most importantly, the US has an unbeatable military. I don't think this factor can be underestimated when considering why a group of people chooses the currency it denominates its assets in. Second, the dollar has been seen historically as a reserve currency with the best liquidity on the planet. That is, the fact that so many people are trading the dollar makes it a more attractive investment as high liquidity, you guessed it, reduces liquidity risk. Moreover, the recent run-up in the dollar can be largely attributed to an international flight to quality. And, I think this flight should be able to silence any economists out there who are still trying to argue that the rest of the world has decoupled from the US.
In short, the US economy is bad, but it is still seen as one of the safer places to park one's wealth.
Is the Rally Sustainable?
In my opinion - highly unlikely. The fundamentals for the dollar are too bad for it to stay at these unsustainably high levels. Once the world panic subsides, which could be in 6 months, 2 years, or 10 years, then the dollar is going to resume its slump towards a reasonable valuation. In my opinion, after this crisis is over, the rest of the world is going to think twice about holding dollars as its primary reserve currency and diversify into holding a basket of currencies. Right now there are too many dollars out there – the Asian appetite for dollar denominated debt will have to be satiated at some point, it's an eventuality. What is that point and when will it happen? I don't know, I assume I will see a "run on the dollar" or several decades of dollar positions unwinding at some point in my lifetime.
The current system is not sustainable. Don't get me wrong, it was great while it lasted – Chinese appetite for debt kept interest rates low and their cheap source of labor kept inflation low. But the day will come when the US debts come due. My advice - keep a short biased on the dollar long term, and make sure you diversify your assets (especially your retirement funds) globally. The home bias is tempting, but it is also very dangerous. I would suggest looking at globally diversified ETFs from iShares. Also, I would recommend taking advantage of this dollar strength to diversify outside the US if you have not already done so.
Conclusion
In the past the mantra has been "America sneezes and the world catches the flu." I think today it is more appropriate to say "America catches the flu, and the rest of the world panics (who is going to buy our stuff?) and decides to pay the medical bills."
Disclosures: None.
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This article has 15 comments:
The dollar will not hold long term so watch what else everyone else is doing for clues....
Remember the scare of China diversifying out of the dollar when the euro was around $1.50? Its silly to buy at $1.50 and sell (or hold) at $1.20 and dropping.
Both the euro and the dollar are fiat currencies buoyed by confidence. So far, the dollar is winning the confidence game. Confidence might continue well past 2009, especially if the US takes decisive measures to end this crisis.
The US is better equipped to revive from recession than the EuroZone and possibly even stagnate Japan.
Hey Kelly, nice to see you posting your typical common sense, and good advice. Haven't seen posts from you lately.
This flight to safety will end, the final drop will start and inflation will start to creep in and finally soar as as the massive virtually simultaneous Global stimulus packages start. If anyone actually believes the USD will rise in the face of rising commodity prices, all they have to do is look back to 2003-2007.
Meanwhile, please note that the USD peaked out at 1.20 dropped to .71 before spiking to the present level. A similar drop will take it down to .40, IMHO
If you're right, and the dollar starts to fall on inflation while simultaneous, global bail out packages begin doing their things...well, that's rather precise timing, don't you think? I just think that's not gonna happen so precisely in that manner.
Yes, we will begin to see inflation pick up at some point, but I believe it will be long after other significant packages have already hit their respective markets. Our recovery is likely to be prolonged, not June 09. Though, spring or summer is not out of the question, just yet.
But, I believe, this author has (or others have) even said we're likely to be in a slump through all or most of 2009. With the rest of the world following us down, they will have acted to fight recession before any real signs of recovery begin at home. Well, that's one consensus, admittedly.
I just do not think we will get back to business as usual, even though we're trying hard to free up our credit markets. As ill advised as that may be, we have to, really. We cannot dump our financial system over night.
But, we probably will transition out of it through new regulations. We've learned a lesson on easy credit and derivative dangers. Our money supply will recover slowly and, I assert, under more Fed control.
MZM growth has been plummeting for some time. Much less money out there to drive the dollar down as strongly as before, in my view. And when inflation begins to rear it's ugly head, I'll bet you'll see the Fed stomp on the brakes.
I will concede the dollar does have some downward pressure, though. That's disconcerting. And it will certainly lose some value as we pull out of this nose dive. But, 40? Yea, if we get back to massive derivative selling and easy money...back to business as usual...sure. But haven't we learned anything? Hasn't the wasp stung us?
Again, it's all about confidence when dealing with fiat currencies. So, will commodities or equities take center stage? Good question. I imagine that depends on many things I am not ready to list here. Maybe you two can elaborate. But, I have listed some details on the dollar I believe are likely to come into play next year.
Remember, it's fashionable to bash the dollar, er, the US peso. It always earns me a "thumbs down." LOL
I wonder if Mr. Warren "Can't get out of the dollar fast enough" Buffet is not playing on the dollar's strength right now. Maybe he can make some of his money back after his bank stock purchases (not clear on what he bought, sorry...and sorry, don't mean to bash Mr Buffet. It just shows that even the smartest people are prone to getting it wrong from time to time.)
America is an A historical country which is beneficial and detrimental at the same time. But from time to time, we need to think about history.
Russian Communism collapsed and the Soviet Union fell apart.
The Chinese and Indian economies are emerging from hundreds of years of paralysis and colonialism.
Europe has suffered from hundreds of years of war culminating in two world wars which almost destroyed European civilization completely.
Japan was crushed by American military might and its economy exists at the pleasure of Americans who could start "buying American" if they think it necessary for the health of our economy.
We Americans see our own faults only too clearly, as is true for any family member who sees the faults of his own family because he lives with them, but we don't see the problems of other countries.
So it isn't only about military might but also about two hundred years of business activity that brought the world modern technology.
We are hated by much of the world for our unscrupulous business practices both in the past and in the present but the world will never deny our superiority in business until our economy collapses completely and we are forced to become a socialist country.
When that happens, American Incorporated will no longer exist and the question of currency values will be answered by committees. Until then, even currency traders will give the nod to history and bet on the dollar.
I think you hit something on the head. To be the leader in a post recovery economy, we will have a lot of work rebuilding not only our social reputation, but our financial one. This is a big reason not to get back to business as usual: unregulated derivatives and easy credit. Bravo...good point.
But, socialism? Ahhhhhh...dunno. I am not a conspiracy guy.
This will result in much higher price levels than previously seen. While the stimulus package(whatever it may be in the US), is being implemented, we will still be suffering from the current crisis. The Fed will be unable to raise interest rate levels.
Should prove to be interesting. IMHO
If anything, I'm being optimistic because I think America is the LEAST tainted of all the large economies.
And I don't think socialism will ever come to America. When the rest of the world are all very tame pussycats living under the domestic peace of socialism, their citizens will tour America in bullet proof tour buses and wont even be allowed to get off the bus except in heavily guarded zones.
They'll watch us shooting it out in the big city streets, battling for drugs turf and sex.
Aldous Huxley painted a very funny picture in Brave New World which was largely a satirical study of America.
Don't forget Huxley's post-post modern designation of calender years using AF instead of AD, where the AF stands for "After Ford"
I think it's better to laugh than cry because I don't have time for bad days and besides that, they're boring.
On Nov 24 12:37 PM Asbytec wrote:
> Wow, Carey_Jim...LOL...pret... harsh. Having a rough day? :) Me,
> too.
>
> I think you hit something on the head. To be the leader in a post
> recovery economy, we will have a lot of work rebuilding not only
> our social reputation, but our financial one. This is a big reason
> not to get back to business as usual: unregulated derivatives and
> easy credit. Bravo...good point.
>
> But, socialism? Ahhhhhh...dunno. I am not a conspiracy guy.
You may have me on the accelerated demand and price thing. But commodities are priced in dollars, so I'll need another cup of coffee to work it out how this will play with a stronger dollar. According to forex forecasts, the euro is only about half way through it's depreciation cycle.
"No nation has ever devalued its way to prosperity." (Unknown) And such devaluation has been a big problem in recent years. Since 2006, we have seen the dollar lose 30% of it's value, and more since 2002. Something is wrong, someone did something sneaky. I suspect it's those same people who are (not really, but should be) paying the price.
Yes, in my view too, very interesting times.
Carey, okay, sorry if I got your tone wrong. I need to work on mine, I am not laughing much...LOL (Well, sometimes...) I just can't help being a little torqued off over the scope of this thing. Maybe looking up that satirical work will help.
Socialism, naaa...a little bit, though. Nothing unusual. What I am worried about is a return to (not so) free markets. One might argue (in fact 'one' is gonna argue) with the influence of the lobby crowd, insurance companies raking in money and refusing to pay out, and Wall Street sticking it to the little guy, our free markets have been so skewed one can argue their existence.
We've (when I say 'we', I mean 'they') have sold off our homes to make money for the credit markets. This means you and I 'feel' richer because we can spend money we don't have...while 'they' actually are richer. Yes, the money supply has grown immensely in the last decade(?) or two, so where's the inflation? In China. One of our biggest exports is inflation.
So, the economy tilts a bit more. Money rolls into wall street's coffers and regulators turn a blind eye. No one complains when one has a Hummer in the driveway and prices are relatively stable. I am arguing we will not go back to that system.
I also realize I am a bit too optimistic. There is just too much power and money seeing to it we do get back to business as usual...easy credit for all Americans. But, it'll be a long time before anyone buys into our (or any) housing market, again, even with transparency.
Well, sorry for the disjointed thoughts, just a bit worn out this morning.
I try to foment dissent by design. Brainstorming on hypotheticals takes focus. I rarely take umbrage simply because I instigated it in the first place. I may get preturbed when I see something particularly inane but I try to maintain focus and, I'm occasionally successful.
Happy Holiday to all.