ECB's Nowotny: No Dollar Shortage in Europe Anymore

Often disputes over the past are really disputes over the present and future. This seems true about the dollar now. One camp argues that the dollar's rally in H2 08 and Q1 09 was a function of safe haven flows. As the acute phase of the crisis abated, the safe haven was not needed and the dollar has generally weakened in Q2 and through Q3 as the safe haven flows were unwound.

The other camp argues that while their was some safe haven demand, the real driver of the dollar's recovery was short-covering. That is to say that the dollar was used as a funding currency--for European banks expanding their balance sheets, for hedge funds buying commodities and emerging markets--Russians, Mexicans, Koreans, and Brazilians, among others borrowed dollars and repatriated the funds to invest at home with higher.

The first camp does not appear to recognize the significance of what appears to have been one of the Federal Reserve's most successful programs. The currency swap lines with foreign central banks. At their peak they amounted to nearly $650 bln. Today less than $70 bln. Those swap lines was to help ease the dollar shortage. The media also appears to have lost sight of this an instead seemed almost enamored with the fact that China entered into $90 bln of currency swap lines. The Fed's swap lines helped avoid turning the financial crisis into a currency crisis.

In recent weeks, the interest in dollar auctions in Europe has waned and the ECB's Nowotny noted that there was not demand at today's longer-dated dollar auction.

One of the implications of the first camp's views is that the market is overweight dollars and the Q2-Q3 decline can be explained be the diversification of these dollar holdings. There seems to be a kernel of truth in this, but seems largely limited to US investors, who are among the largest cross border equity investors. Public and proprietary data indicates Americans have moved back into overseas markets this year.

However, foreign investors seem under-weight US equities and the dollar. It does not mean they cannot get shorter, but the point is that what the first camp misses is that the dollar again has become a funding currency and that is again the source of its weakness.

Comments

[AJ Clausen:]

I would like to know one single reason why to invest in currency of the United States - besides Obama.

Sep 11 08:32 AM

[Albert Meyer:]

"The first camp does not appear to recognize the significance of what appears to have been one of the Federal Reserve's most successful programs. The currency swap lines with foreign central banks. At their peak they amounted to nearly $650 bln... The media also appears to have lost sight of this..."

Perhaps ypu cold explain to those in the media and simpletons like me, how these swap lines were instituted and how they distort the normal flow of funds?

I was in the first camp, until I read this article, which is why I appreciate your contributions. A previous contribution, which highlighted the fact that part of the trade deficit is just US companies importing finished goods from their foreign-owned manufacturing plants, was a reminder of very imporant fact when people get all antsy about trade deficits. There is more than meets the eye, as also in the case with these swap lines, but not that obvious.

Sep 11 01:17 PM

[Marc Chandler:]

AJ Clausen--I did not say one should buy the dollar here or invest in the US dollar whatever that means. And one compelling reason why short term speculators should not be so bearish on the dollar is because so many--the vast majority of people, like yourself, are very bearish and are confusing, imho, cyclical forces for structural. I believe Robert Prechter of Elliott Wave fame cited a 5% bullish sentiment number. Sounds extreme to me. New dollar shorts now are going to a New Year's party after midnight.

Albert Meyer--My hypothesis is that the reason the dollar rallied as the crisis become more acute is not so much its safe haven status as the fact that many people, investors and institutions, were effectively short the dollar--(using the dollar for a funding currency). There was a large currency mismatch if you will and when push came to shove these folks needs dollars. There weren't enough around. They did not have access to the Fed. US banks where charging a fortune if willing at all--see the spike in LIBOR (london interbank offered rate). Through the swap lines the Fed made dollars available to the foreign central banks, who then would auction them to their members. This address the dollar shortage problem in a way that intervention might not have and would have sent arguable ambiguous if not counter productive signals.

Sep 11 05:43 PM

[Reginald Si...:]

Mr. Chandler,

If you see strength coming in the USD and I agree with your assesment that it may be dangerous to short the USD at this moment.

How do you think the zero interest rate policy will continue to affect the USD if the USD is now going to become the carry trade of the future? This would imply a very, very, very long term policy of ZIRP, correct?

And today, 15 Sep 09, I noticed that the RSI of the USD/Gold chart is again in extreme oversold conditions.

I also say the dollar will gain strength in another debt destroying episode. Even now dollars are precious to the banks and I believe this is one of the reasons they are forcing customers to pay back the credit cards or face jacked up interest rates.

I believe we are going to test the 74 level and if that doesn't hold then the lowest low ever of 70.68 and if that doesn't hold then I am not certain our policy makers have any respect for the Common Man and the forces of inflation that will destroy the USD possibly.

This is why I continue to HOPE that we are at the end of this Dollar Destruction Devalued Rally that started back in 2002.

If not, then we are screwed.

Sep 15 05:18 PM