In all the anguish over the recent decline of the dollar, two simple facts seem to have become misplaced.

1. A very large amount of the day to day positions in the currency markets and thus the negative movement in the dollar is the result of traders chasing profits. It is obvious but worthwhile to state again that these are trading markets and trading markets are all about trading profits. Currency markets are not designed, at least in their day to day valuation, to make judgments about the viability of a currency’s reserve status.
2. As soon as the Fed signals that its easy money policy is at an end a great percentage of those traders who are now avid dollar shorts will reverse and become with equal sincerity dollar longs. New punters who see profit potential in long dollar positions will soon join the ex-shorts as the Fed begins a rate cycle that might last two years and bring the Fed Funds rate back to historical norms. The dollar will follow the funds rate higher.

The world’s disenchantment with the dollar as reserve currency is new. Only eight months ago the dollar was all the rage. The world fled to the dollar and dollar assets as global financial markets imploded. If another crisis struck tomorrow it is unlikely that the world seek financial refuge in a different national script and government? The current trading equation of risk and reward is a dollar based concept; as risk rises so does the value of the dollar. This logic remains true. If this aspect of the dollar’s place in the world economic system has not really changed what then are the motivations and logic of the critics of the dollar’s reserve status?

The spectacular rise in gold, now hovering in record territory, has been fostered by three very different conceptions: gold as a trader’s choice, gold as a theoretical proof and gold as a historical metaphor.

For the believers in metaphor the ascent of the metal is an augury for the decline of the West; for the theoreticians it is the only secure defense against inflation; for the traders it is a momentum purchase not to be missed. All three groups are buying gold and, as yet, none have been proven wrong.

The yen carry trade was one of the great runs in modern currency history. A long position opened in late in late 2003 and held until mid-2007 appreciated over 30% in capital and could have earned upwards of 7% a year on the interest rate spread. At the trade’s height from mid-2005 until the summer of 2007 the trajectory of yen crosses rose with barely a correction.

Japanese rates in that period never rose above 0.5%. The worldwide lure of yen funding was not only the extremely low cost of money but the knowledge that the Bank of Japan (BOJ) could not raise rates.

One of the most surprising developments of the financial crisis and recession has been the continued strength of the Japanese Yen.

The return of relative stability to the world financial system has not prevented the yen from retaining the majority of its crisis induced advances. The Japanese currency has held on to about 75% of its gains against the dollar, 65% versus the euro, 60% from the aussie and 75% from the sterling. In comparison the dollar has retained only 47% of its euro gain, 33% of its aussie improvement and 56% of its sterling take.

Have the Chinese engineered a spectacular economic recovery, the envy of the industrial world, or has Beijing created a version of the American housing and credit bubble of the past decade?

The China jury is still out. But despite the evident confidence in the mainland story shown by the commodity and currency markets, there are worrying signs that the end of the government stimulus spending will seriously dampen the Chinese economic resurgence.

The reaction of traders to Friday’s Non Farm Payrolls may be the most concrete sign that the currency markets are coming to the end of the financial crisis. The initial response was, as it has been since the unwinding of the security dollar bubble began in March, to sell the dollar against the euro. But the dollar sellers exhausted themselves after barely five minutes and the following dollar surge, though also five minutes, covered twice a much ground. From 8:30 am to 8:35 am euro rose 34 points, from 8:35 am to 8:40 am it dropped 76; good American economic news had finally garnered a positive response from the currency markets.

The rise of the Australian and New Zealand Dollars from the depths of March to their current levels has been an Asian success story.

Chinese economic growth has cushioned the effects of the worldwide recession in New Zealand and Australia. Both countries export large amounts of raw materials to Asian manufacturing centers, China foremost. The yuan is fixed to the dollar (unofficially); the aussie and kiwi are not. The Australian economy has avoided recession; the New Zealand economy shrank just 1.0% for two successive quarters. As China returns to strong economic growth and the potential for internal unrest diminishes, the two Asian Dollars rise, and everyone in Asia benefits.

Since late May the dollar has traded in a limited four figure range against the euro - limited and a bit odd. Good American economic news pushes the dollar down; bad news returns it to favor.

May Non Farm Payrolls, unexpectedly positive, gave the dollar a fainting spell. The June numbers, worse than predicted, revived the greenback. Retail sales figures and consumer confidence have gradually returned from oblivion and the value of the dollar ebbed as they rose.

The origin of the Group of Eight was an invitation from French President Valery Giscard d’Estaing in 1975 to six of the major World War Two combatants to meet at Rambouillet in France. Leaders from West Germany, Great Britain, Italy, the United States, Japan and France attended that first meeting. The impetus to the summit, if not the sole topic, was the first post war economic challenge to the west, the 1973 OPEC oil embargo. In 1976 Canada was invited to join and the group stayed at seven until 1997 when Russia formally became a member.

Although formed a generation after the end of the Second World War, the G-7 represented the dominant nations of the defining event of 20th century history. As with the United Nations for international politics, the G-7 was an attempt to secure the victory of the western economic model. For the first 30 years after the war the only antagonist for the western capitalists had been the political and military threat of the Communists led by the Soviet Union. Until the oil embargo there had not been a serious economic challenge to Western Europe, the United States and Japan.

In the past three weeks there have been several indications that the Federal Reserve is reconsidering the extent and perhaps necessity of its extraordinary liquidity provisions to the Treasury market. How far have the chairman and governors pulled back from their quantitative easing policy?

On June 3rd Chairman Bernanke commented in Congressional testimony that federal deficits cannot continue forever. In fact the deficits can continue, but the Fed’s $300 billion Treasury purchase plan will end unless additional funding is authorized by the Fed governors.

After a few months out of the currency spotlight, the Federal Reserve will once again be the focus for traders when the Federal Reserve Open Market Committee (FOMC) meets today and tomorrow. This time it will not be the Fed Funds target rate, the central bank’s chief historical policy tool, that will be the locus of interest, but the several special programs that the Fed has used to stem the financial crisis, in particular the quantitative easing attempt to cap Treasury interest rates.

Various Fed disbursements have added more than one trillion dollars in liquidity to the United States financial system. With up to $3.25 trillion in Federal debt sold or slated to be sold in the credit markets before the end of the US fiscal year in September, oversupply and inflation are serious potential concerns that could drive Treasury interest rates considerably higher.

• The currency market view of quantitative easing
• Monetization or a stable dollar
• The normalization of Treasury rates
• A foreign veto on quantitative easing?

After a few months out of the currency spotlight the Federal Reserve will once again be the focus for traders when the Federal Reserve Open Market Committee (FOMC) meets this coming Tuesday and Wednesday. This time it will not be the Fed Funds target rate, the central bank’s chief historical policy tool, that will be the locus of interest but the several special programs that the Fed has used to stem the financial crisis, in particular the quantitative easing attempt to cap Treasury interest rates.

Various Fed disbursements have added more than one trillion dollars in liquidity to the United States financial system. With up to $3.25 trillion in Federal debt sold or slated to be sold in the credit markets before the end of the US fiscal year in September, oversupply and inflation are serious potential concerns that could drive Treasury interest rates considerably higher.

• The divergence of Treasury yields and the dollar
• Fed rate policy--double bind or double blind?
• Quantitative easing and the long term value of the dollar
• The 10 year yield returns from oblivion

• Higher consumer sentiment is not the gateway to recovery
• Consumer debt reduction continues at high levels
• The Fed conundrum: fund the government or the consumer
• Relief is not recovery

The factors driving the dollar seem to vary with the season. Last fall at the height of the financial crisis safe haven flows trumped all considerations; at one point investors accepted zero return for the security of holding US debt. The dollar rose 17% against the euro in a month and made similar gains versus the pound Sterling, the Canadian dollar, the Swiss franc and the Australian and New Zealand dollars. But even at maximum market panic dollar superiority was not total; the imploding Yen carry trade drove the dollar down against the Yen to 90 to the dollar despite the huge inward flows to US securities.

The dollar’s virtues last fall were very specific; in a catastrophe everyone’s first choice for safety was American debt. The dollar’s competitive value was not the point, only its supposed security mattered. But those conditions could not last, and as the financial crisis became an economic crisis and the threat of financial system collapse waned the fear of wholesale loss of investment principal ebbed. In moderating circumstances the funds that had been stashed in the States for safety (and little or no return) began to be withdrawn seeking other more productive currencies and investments.

Thursday and Friday presented the unusual spectacle of American equities, Treasuries and the dollar all falling at the same time.

The price of 10-year Treasury Notes dropped more last week than any week since June 2008; the rate rose above 3.4% for the first time since last November. The dollar tumbled below 1.4000 to the euro for the first time this year. Its 3.6% loss for the week was the largest decline against the euro after it sank 4.8% in the five days to March 20th. And the Dow declined four days out of five, rising over 200 points on Monday but finishing the week flat.

Economic analysis anticipates the future through mathematical equations. If interest rates are reduced by a certain percentage, then the economy can be expected to grow by x factor. The difficulty in accurate prediction arises from the assumptions disguised within the formulas. For the American consumer it is beginning to look like one of those basic assumptions has changed. The consumer that reliably spent most or all of his or her disposable income has become a cautious, price conscious shopper. Value and replacement rather than consumption and excess have become the bywords of the family budget.

If this change in consumer spending habits is permanent then predictions of economic growth based on an assumed level of consumer spending relative to income will overstate potential future GDP expansion. The government may send stimulus checks to the entire population but if the money is not spent the economy will not move.

There are two standard definitions of recession. The first, two succeeding quarters of negative GDP is traditional, straightforward and evident as the statistics are released. By this definition the United States has been in recession since the third quarter of 2008 when the economy contracted by 0.5% followed by a negative 6.3% in the first quarter of 2009.

The second definition is compiled by the National Bureau of Economic Research (NBER), a private research organization, and uses a far more elaborate set of criteria to determine ‘business cycle’ turning points.

Has central bank currency intervention gone out of style? Two extreme cases in the past year should have beckoned intervention: the all time high of the euro against the dollar last summer and the 15 year high of the yen in late January. But despite the damage that was being done to the European and Japanese exports by their strong currencies neither central bank intervened. Why have central bankers eschewed one of their primary tools for effecting violent change in the currency markets?

At the time, Jean Claude Trichet, the President of the European Central Bank (ECB), certainly tried to talk the euro down. He was ‘concerned’ about ‘disorderly’ currency movements, central bank euphemisms for what the bankers see as incorrect trading rates. There was also no shortage of European complaints about the level of the euro and praise for the United States ostensible strong dollar policy.

It has been a long road for the European Central Bank and its head Jean Claude Trichet. In less than a year, the most anti-inflationary of the world’s central banks has moved from strict monetary conservatism to the verge of sub 1.0% interest rates and to serious consideration of quantitative easing, leaving many principles in its wake.

It is not the fact that the ECB has followed the rest of the world’s central banks in pouring liquidity into the banking and monetary systems of Europe that is surprising but that at almost every step of the road they have either denied that such actions were contemplated or indicated that the end to these policies could be imminent. Their rhetoric has proved a far less than perfect guide to their actions.