The worse the US does, the better the dollar does …
The dollar hasn’t fallen along with the US stocks, US Treasury yields or US employment. There is now a broad consensus that the US is currently in a recession, something that might be expected to lead to a fall in the dollar.
But the dollar, instead, has rallied. Against the euro. But also against a host of Asian currencies and commodity plays like Brazil and Russia. And it is soaring against the Icelandic Krona …
Some have called this a flight to quality. That though doesn’t seem quite right. The US is the source of much of the bad debt that has brought the world’s financial system to a near-standstill. The default of a US institution — Lehman — triggered the current panic in the shadow financial system. The price of “insurance” against the risk of a US government default suggest that US government debt is now considered a bit more risky than German government debt.
Rather this seems to be a flight away from risk.
Remember, the dollar rallied last August too, for the exact reason jck of Alea highlights.
Of course, there is now a new dynamic at play as well — namely mounting evidence of a broad global slowdown, and a sharp slowdown in Europe. That is quite different from last August, when the US slowed and the world didn’t. The dollar has to have something to depreciate against … and right now there aren’t many good candidates.
But there is also reason to think that the dollar’s current strength reflects something other than the United States relative economic fundamentals. A recent research piece from Sophia Drossos and Yilin Nie of Morgan Stanley argues that global deleveraging is a major current source of support for the dollar.
Drossos and Nie note that US banks have grown reluctant to lend to banks abroad — and many banks abroad have significant holdings of dollar debt and thus need dollar financing.
“increased issuance of US debt (partly due to the securitization boom) has resulted in foreign[er]s increasing their holdings of US debt. These USD denominated assets need to be funded in USD. Even under normal circumstances, there is a limited supply of USD overseas. The natural sellers of USD in global funding markets are US based banks with large deposit bases. But in times of heightened market frictions, banks are reluctant to lend at all given the increased uncertainty about their own funding needs. As US-based institutions have scaled back their overseas lending, the premium for USD LIBOR has increased significantly.”
The solution to a world where US banks won’t lend to the global funding market? Simple, the US central bank lends dollars to European central banks who lend dollars to their banks — dollars that European banks can no longer get from US banks. Call it cross-border central bank intermediation. this is why the Fed has, in some sense, become a global lender of last resort.
Drossos and Nie also highlight a dynamic that observers of currency markets know well — a carry trade unwind.
“USD has been a low-yielding currency for some time, and US policy rates are now the second lowest in the G-10 [Setser note, after Japan] — a fact often overlooked by market participants. The US-specific nature of the slowdown in H1 2008 likely only fueled expectations that rate differentials would continue to move against the USD. Our sense is that this had two major consequences: (1) an increased amount of FX carry trades began to be funded in USD over the course of last year; (2) US based investors increasingly sought higher returns abroad.”
In other words, the US became the new Japan after the Fed’s rate cuts — despite a large current account deficit. And the US dollar has started to act like a “funding” currency in times of stress. And in general, when risk aversion goes up and risky bets are pulled, funding currencies rally …
The net result, though, has been rather surprising in a lot of ways: dollar strength amid US economic and financial weakness. I at least don’t think we really know what the long-term impact of the current crisis will be on the dollar. Zhou Enlai’s classic quip about the French revolution applies with force.
We still don’t know what will happen once the forced buyers of dollars by actors scrambling to repay dollar debts ends. The US will likely still have a sizeable external deficit that needs to be financed for a while longer, which could drag the dollar down. On the other hand, the US won’t be the only country in a recession. Rather than competing in a beauty contest, the dollar is the United States entry into a competition that will be “won” by the country considered to have the least ugly currency in an increasingly grim world.
Brad, do you think some EM will default on their sovereign debts? Not sure if Iceland/Ireland count as EM… Maybe the Baltics will go belly up in this cycle?
Brad,
I do not envy people who’s job it is to write seriously about finance these days. But attributing at least part of current strength to inadequate supply of short term USD funds to non-US holders of financial assets (probably highly illiquid and carrying unrealized/unrealizeable losses in many cases) seems to be a pretty good suspicion.
Looking at the increasing scale of CB intermediation and financial institution nationalization our recent attempts at guessing Chinese macrofinancial reasoning seems pretty quaint..
May order return soon and bring Prosperity along!
Brad,
I have some questions regarding swaps between Fed and foreign central banks. What are the terms? What collateral is Fed getting? Is it potentially profitable? What is the timing? At the same time, while borrowing from their central banks to fund their current liabilities, these entities will eventially need to buy dollars anyway to pay their loans.
Best,
PG
One use of these dollars, reported by European Central Bank, is overnight lending. Their website provides details, if you can understand it. One tender Operation involved 50 billion dollars tendered on 03/10 with a maturity date of o6/10. Presumably, these dollars will be repaid in 3 days. Other types of loans are described.
This money that comes from the FRB is a swap, not a purchase. The FRB is getting in return, from the other Central Bank, currency of the other nation.
Presumably, the same forces, whatever they are, that are pushing upward the exchange value of the dollar (money coming to the U.S.) would also tend to push down the interest rate paid for U.S. Treasury bills.
The rationale response to these events, by the U.S. Treasury, should be to sell as many Treasury bonds as possible while the market is in our favor.
All us nervous Nellie’s are looking over our shoulder, expecting to see market pressures going the other way. Who has a prediction as to when and why these favorable winds will reverse?
Sophia’s name is Drossos……unless you really don’t like her work!
PG,
I do not believe that details have been published, but I set out my thinking about how the swaps work in a post on my blog: http://reservedplace.blogspot.com/2008/09/beware-rising-custody-holdings.html
If anyone does know of a published account, I would be interested.
Rebel — thanks for catching that. The post has been edited, as you were (of course) right.
PG — the Fed receives foreign currency in exchange for dollars, and the central bank that receives the dollars promises to return them in exchange for the foreign currency it provided the fed. I do not know the interest rate on the swap.
Forgive me for bothering you all with a question about interest on swaps from a non-specialist.
Aren’t swaps notionally a transaction between similarly placed parties? Let’s suppose the Fed gives the ECB $1 billion, and the ECB gives the Fed an equal value in euros. Let’s further suppose the dollar interest rate is 2% and the euro interest rate is 4%. Shouldn’t the Fed pay the ECB 2% interest, the difference between the two rates, rather then the ECB pay the Fed?
Hank Paulson and the Treasury Department are engaging in the most massive tax fraud in the history of the United States by devising a “sham” acquisition structure for Fannie and Freddie which will arguably allow these failed entities to take approximately $80 Billion in tax deductions per year. This tax fraud dwarfs any scheme in history. Why did the acquisition of Fannie involve warrants for exactly 79.9% of the common stock at a price of .00001 dollars per share (essentially zero though by the time Bernanke and Paulson get done debasing the dollar in a manner which would make Stalin and Mao proud, it may be less than zero)? Well, Section 163(j)(6) provides that if a related exempt organization (the Treasury Department) controls a corporation (in this case Fannie) and the exempt organization guarantees the debt of such corporation, the interest expense on such guaranteed debt is nondeductible (or subject to severe limitations) for tax purposes. Treasury has clearly guaranteed the debt of Fannie as defined under section 163(j)(6)(D)(iii). Related person is defined under section 267(b) which provides the corporation must be controlled by Treasury. Control is generally defined by the IRS as owning 80% of the corporation. Thus, Hank and Treasury hope to evade taxes on $80 Billion of income per year based on acquiring only 79.9% of Fannie and thus, defeat their own tax law notwithstanding Treasury effectively owns 100% of Fannie. Interestingly, the Treasury actively throws commoners in jail for life for interpreting the tax law literally as the Treasury argues the non tax paying miscreants violated the spirit of the law under the so called economic substance doctrine (an undefined vague legal concept universally interpreted differently by most courts). In fact, a literal interpretation of 163(j) via its underlying regulations specifically requires that the transaction be analyzed based on the substance of the acquisition under the 1.957-2 regulations which is a catch all provision for any legal machinations to avoid the tax law. Most of the dudes Treasury puts in jail for life for interpreting the tax law literally are using tax laws which have no literal corollary to 163(j) (i.e., no legal requirement to look at the substance of the transaction). Hank Paulson may be the biggest tax fraudster in history: not only did he avoid taxes on $100 million of his Goldman stock through the use of 100% controlled private foundations; illegally change the law under Section 382 to provide tax benefits in the realm of $750 Billion to his friends on Wall Street (which under Section 7201 is likely tax evasion (the intentional violation of tax law to avoid taxes)); but now he is engaging in further tax fraud to the tune of $80 Billion of tax deductions per year (for interpretations of the tax law Treasury sends people to prison for life over) yet again for the benefit of his buddies on Wall Street. If Hank was judged by the same standards he judges others, Hank would have to go to jail for life (notwithstanding all of the securities fraud he has engaged in).
Great choice of topic. A few points for your consideration:
1. I do not need to tell you that currencies can be overvalued or undervalued for a long time for plenty of reasons. Herd mentality and carry trades always push a trend to overshoot.
2. Having said that, the euro and the pound are now overvalued compared to the dollar according to some criteria (say what you want, there is some value in the Big Mac index and the like).
3. The US economy has its problems but the current account will shrink dramatically because the US consumer is (finally) cutting down. Who knows, this consideration may turn out to be one of the reasons traders are buying dollars.
I will not be surprised to see the euro very soon back to where it was when first introduced (I think 1.17$/euro). Hard to say for sure. But, if that is the case, it will not necessarily be a sign of weak Europe or strains in the euro zone and other predictions of doom and gloom about the common currency. Europe will generally benefit from a slight weakening of the euro and policy makers there will applaud it.
PS Please do not be swayed by anti-European British Papers (like the Telegraph) who constantly predict the demise of the euro. Poor Brits, they cannot tolerate that the French and Germans can get together or that the “Club Med” countries can both do well economically and enjoy good climate.
On the day the US stock marktet was well on its way to a 777 point drop, foreign central banks bought 620B phantom dollars. That should have been enough to crank up the value of the USD. Without that immediate foreign central bank intervention, the market could have dropped far more than 777 points.
Cobble together Bush’s projected budget deficit with the $620B swap, $138 for JPM, $85B for AIG and the $850B for the bailout plan, and that stacks another $2 trillion on top of the present $9.6 trillion National Debt. Figure in a paralyzed US economy, unending expensive wars, an Alt-a and prime jumbo loan implosion, along with state and municipal insolvencies, and the USD should’t remain strong for much longer.
Long term or even medium term how anyone has faith in the dollar or low Treasury rates is beyond me. Admittedly I am a dope and can only do simple math but I know when you borrow today to pay back tomorrow with contingent revenue streams, eventually the shell game ends. Let’s see, the U.S. Government 07 tax revenues were about $2.3 Trillion comprised of about $400 Billion in corporate taxes and $1.9 Billion of income taxes (numbers could be off). Approximately, 50% of the income tax revenues were generated from the top 5% income earners from which a substantial portion of those profits were derivatives of the stock market, don’t look like those dudes will fare very well in 08 and beyond. As for the corporations, many will have losses this year and be requesting tax refunds from loss carry backs (I think financial services represents something like 30% of corporate income). Assume tax revenues remain constant in 08 at $2.3 Trillion, how the U.S. government can continue to be the lender of last resort with its $11.5 Trillion (soon to be) national debt, $7 Trillion GSE debt guarantee obligation, $60 Trillion present value entitlement obligation and rolling presumptive annual deficits of $700 Billion from the budget and $700 Billion from trade deficits is beyond this simpleton. Since tax revenues will likely decline from 08 and forward, should the U.S. government be loaning money to anyone? I would be more concerned about who will continue funding the U.S. voracious deficit spending needs with its massive debts and declining revenue stream. Remember, the U.S. economy is 70% debt financed consumption based, 30% of GDP is fake, about $16.5 Trillion of financial services debt exists, credit spreads are at unheard of levels (over Sigma 6 deviations), real estate will likely revert to the long term mean best case scenario….it seems more likely to me that the $700 Billion will be blip since the Politico heroes have already thrown about $1.5 Trillion at the problem they claim did not exist to begin with and the dollar will devalue and Treasury rates will rise.
Given that “the dollar is the United States entry into a competition that will be “won” by the country considered to have the least ugly currency in an increasingly grim world”, isn’t it interesting that gold crashed last week? If all the world’s ‘faith-based’ currencies are becoming increasingly undesireable, what is left?
Kafka, compared to you, I, a serious doomer, come off looking like an optimist. You’ve out doomed me.
Black Swan, I am optimistic about making dough off the lies of Politicos and Corporate miscreants. Long term short the dollar and Treasuries. Medium term to short term, use charts and trends and it is almost impossible to lose money on currencies. And the ace in the hole, short debt financed consumer product companies and selected insurance companies (if you can). That is glass half full isn’t?
I like the beauty contest explanation, but looking for a more detailed technical flow explanation, the only one I can think of would be this.
The treasury is selling T-bills like crazy to raise cash to give to the Fed, who in turn is spreading it around the world. So far it seems stuck somewhere in another central bank or commercial bank. If the fed were selling their stock of t-bills for dollars, we would call that a fomc transaction that mops up excess liquidity(sorry for using confusing terms).
So if that idea carries any water, the dollar rally would be very short term, i.e. it reverses as soon as the intended effect of increasing liquidity begins to work.
Also, being a funding source for the carry trade reduces the value of the funding currency. For example, usually Japan is the biggest carry funding source and this has made it unnecessary in recent years for the BOJ to intervene to weaken the yen. They have capital flight looking for yield elsewhere in the world.
At the moment the yen is the strongest currency vs the dollar because of risk aversion and the unwind of carry. And similarly, a repatriation of US funds abroad has been helping the dollar.
Recent Dollar moves have been
1. vis a vis macro weakness and fundamental shifts in the other currencies i.e rumours of rates cuts/ economic outlook weakening
2. shortages and high demand of USD sparked higher funding costs and recent credit issues shrank interbank swaps markets, thus resulting in some outrite selling cash eurs for usds.
3. usual story of risk unwinding n business repatriation flows.
Like it or not, USD hegemony is still around though gradually weakening. Gold and other commodities are still priced in USD. End of the day, like Brad says, USD is still one of the best among the worst. Besides, almost everyone has a pile stashed somewhere, problem is who has a bigger pile and are there any better alternatives now?
Here’s a forex note on the euro as an entry
And the coming coordinated rates cuts among the high yielding countries make the yield differential less for carry countries. Also it’s hard to imagine anyone wanting to chase equities worldwide until the recession bottoms and shows some sign of ending.
in the “ugly contest”.
They do think Trichet will cave soon and cut rates. Also the recession and bank crisis there are thought to be in the beginning stages, and much more deterioration is to come. So this will be the first time the ECU & ECB are stress tested in bad times. And most of the region already has high government debt, so the cost of fixing things there becomes a sovereign credit rating problem in the end too.
Then there is Britain and its rumored to be worse than the US housing bubble.
So ironically, at least for the short and maybe medium term, the winners of the least ugly contest are the carry funding countries…Japan the Swiss, and the US.
Any safe haven in lesser currencies? Nothing really comforting. Sweden with high baltic lending exposure, Norway maybe, but declining oil a problem, Canada depends on oil pricing and US trade, Mexico has rapidly declining oil production, although has made some progress diversifying from US trade dependence. Korea may be headed for a currency crisis, Asian tigers need the US consumer still, …have I missed anything?
http://www.dailyfx.com/story/currency/eur_fundamentals/Euro_May_Be_Closing_In_1223078981270.html
Back in May 08, a prediction/vision was written about the dollar, stocks and commodities. The price action has vindicated that prediction.
What is interesting in that prediction is the WHOLE reasoning of why things would turn the way they did. And they turn exactly as explained in the article below.
A FASCINATING and a MUST read.
http://financialtraders.blogspot.com/2008_08_03_archive.html
PS: I do not have the permalink, but when I find it I will post it–I emailed the editor about it.
Permalink is found. Post with permalink is below.
“What is interesting in that prediction is the WHOLE reasoning of why things would turn the way they did. And they turn exactly as explained in the article below.
A FASCINATING and a MUST read.
http://financialtraders.blogspot.com/2008/08/dollar-equities-stocks-and-commodities.html
“
“So ironically, at least for the short and maybe medium term, the winners of the least ugly contest are the carry funding countries…Japan the Swiss, and the US.”
Except, the Swiss franc, which actually has some implied gold reserves behind it, has tanked in the short term.
I would attribute dollar strength primarily to a rational market reaction to the (correctly) perceived US government bias in favor of foreign debt holders over its own citizens. By far the most dramatic of all the Treasury’s moves has been to placate holders of GSE debt, specifically Chinese, Japanese, and Middle East central banks and sovereign wealth funds. Can anyone have missed the significance of this? On the other hand, one gets a sense of naïveté on the part of the Asians and other foreign investors — – do they really think that in the long run the US politicians, who after all need to get reelected, will not “default” on the foreign debt by inflating the currency? That might not happen now during the crisis, but ultimately it’s the likely move.
At least of portion of this is attributable to a ‘eurodollar short squeeze’ based on the deterioration of US denominated debt instruments.
http://tinyurl.com/4mxed4
I’d agree with Brad. It’s very difficult to borrow dollars, so some banks may be taking the risk and just exchanging for them, which pushes the dollar up.
There’s also the effect of oil prices coming down (and just less oil bought by the U.S.), which means the U.S. trade deficit is coming down -sharply, I imagine.
“By far the most dramatic of all the Treasury’s moves has been to placate holders of GSE debt, specifically Chinese, Japanese, and Middle East central banks and sovereign wealth funds.”
MGK, I’d like to see some evidence that the Chinese are still buying agencies in quantities anywhere near what they were buying before the takeover, before I will believe they have been placated.
—-
Equivalently, bank dollar hoarding translates into higher Libor rates, which equates to monetary tightening by the private sector (although resisted by central banks), which induces a stronger dollar. This affects both non-currency-hedged transactions and hedged ones (i.e. Libor plus the forward exchange rate differential, which will adjust partly through spot exchange rate strengthening). The interest rate differential effect may be compounded if economic prospects for the world outside the US are deteriorating at least as fast as those for the US, and if foreign central banks are perceived to be behind the curve in easing.
You can speculate until the cows come on why the dollar is strengthening, it will not matter. I believe Mr. Setser is indeed correct but also believe that dollars are effectively being repatriated in a time of crisis causing a temporary bump. Check out the Euro in 2005 when many U.S. companies repatriated funds to take advantage of the tax holiday on foreign earnings, the Euro went from 1.35 to 1.15 and back to 1.35. Dollars are now being repatriated based on fear, need and the implicit tax holiday from massive financial losses which eliminate taxes. You can also be assured there is some form of coordinated intervention occurring amongst the Central Banks to assuage the U.S. foreign masters holding substantial reserves. At the end of the day, you can apply all the econometric analysis you want, the math is simple, you can’t beat a “liquidity trap”, all the rhetoric and analyses on the planet will not solve one the most massive liquidity traps in history. Perhaps more debt will defer or smooth out the insolvency issues for a time but more debt can not and will not solve the liquidity trap which necessarily requires a reversion to the mean. And all you lovers of Buffet ought to go read his simple article on Squanderville from 2003 (which apparently the bottom feeder is now ignoring for his own financial gain), more production, less consumption and less debt are the only answers; which I do not see ever happening especially if you listen to your Politico heroes.
maynarGkeynes says 6 comments above: “On the other hand, one gets a sense of naïveté on the part of the Asians and other foreign investors — – do they really think that in the long run the US politicians, who after all need to get reelected, will not “default” on the foreign debt by inflating the currency? That might not happen now during the crisis, but ultimately it’s the likely move”
I think he is mostly right… if only -I would add- that US has ALREADY “defaulted” on the foreign debt, or at least of a great chunk of it. The worthless mortgage backed bonds, most of them bought by foreigners,…2 trillion I reckon, is a nice and neat solution to the problem of American foreign debt that has worried us on the past years. While the default was in progress in 2007 and begining of 2008 dollar deteriorated sharply; now that is coming to and end, and with much less debt remaining the dollar looks promising. Exactly the same process that the turnaround of the brasilian Real.
“While the default was in progress in 2007 and begining of 2008 dollar deteriorated sharply; now that is coming to and end, and with much less debt remaining the dollar looks promising. Exactly the same process that the turnaround of the brasilian Real.”
Felix, you must live in a parallel universe, if you think the US is making a U-turn away from defualt and creating more debt. The US just added a potential $2 trillion to the national debt, and no country, that has ever amassed this kind of debt, has ever paid it back. The US is not even halfway trough the housing foreclosure crisis, and is only just entering the municipality bust collapse. If that’s not enough, wait until you see the CRE collapse.
As far as Brazil’s real, what the commodity bubble giveth, it taketh away.
yea, comparisons w/ japan only go so far re: savings and the current account, viz. “the US can only wish it were Japan,” but i’m not sure how much “financial development… size, liquidity, efficiency and transparency” counts for, altho ppl like MS’ jen and apparently summers and rubin thinks it explains a lot…
i’d just say that inertia (and complacency), more than putative ‘financial development’, probably has more explanatory power, cf. zakaria’s post-american world… oh and i’d also add that for an economy the US’ size, financial engineering cannot replace engineering, for example, altho it may contribute to the US’ dynamism, i.e. it was probably unhealthy that financials grew to 20%+ of the US’ market cap as its ‘debt export’ machine ramped up (as documented so assiduously by setser, et al, or buffett’s innovators, imitators to idiots progression/expression
— relying on others’ (relative) complacency & inertia tho shouldn’t/isn’t a strategy that anyone should take comfort in, imo, esp in light of recent comments by yu and wen, viz. where he hits all the buzzwords wrt safety nets…
btw zhou enlai’s other ‘quip’ is so chinese! (inverting clausewitz
the battle is won before it is ever fought 
anyway, bottom line for me is that if the US is to retain its credibility/credit line, it needs to reduce its debt thru strucutral adjustment (not of course thru default or inflation, note the monetary base is spiking) but as bacevich points out:
“The American way of life is not up for negotiation. What I would invite them to consider is that, if you want to preserve that which you value most in the American way of life, and of course you need to ask yourself, what is it you value most. That if you want to preserve that which you value most in the American way of life, then we need to change the American way of life. We need to modify that which may be peripheral, in order to preserve that which is at the center of what we value.”
cheers!
black swam is right, I live in the parallel universe of Europe where I can not see how the deteriorating situation in US that he so well describes will turn up in a relative strenghtening of the euro ( -by the way- is not good for Europe) which is what we are discussing. This is only the same as to say that the global situation looks very complicated… kind of parallel deterioration.
Brad,
There is a much simpler explanation for the rise in the dollar that is consistent with the statistic you reported last week that foreign Central Banks have been financing the entire U.S. current accout deficit.
China and other countries are following the same mercantilist strategy that Japan followed throughout its decade-long recession from 1992 through the end of 2002.
They are keeping their money supply tight, in the face of recession, and are trying to stimulate their economies by buying ever increasing amounts of dollars and euros, in hopes of decreasing the value of their currencies in order to stimulate exports.
During the Japanese recession, unemployment rose in Japan from 2.1% in 1991 to 5.4% in 2002. According to Milton Friedman, writing in 1997 ( http://www.hoover.org/publications/digest/3531496.html ), the Japanese Central Bank could have cured their recession if they were willing to increase the money supply, making more credit available to their onw people.
Finally, in 2002, they increase their money supply by 36% in a single year. The result was that Japan’s unemployment rate began a turnaround in 2003.
Howard Richman
http://www.tradeandtaxes.blogspot.com
Jesse: your post ref. http://tinyurl.com/4mxed4 added some clarity in my mind of why the powers seem so concerned about eurodollars lately.
I understood the part about Libor rates making our variable rate mortgages and other loans go up for some time now. And I even had a foggy notion that US banks may borrow excess euro and petro dollars from Euro and London banks in order to make mortgage and consumer loans in the US (just a guess on my part).
But this post reminded me of another actor in the system…multinational corporations. Now that the window closed on tax reduced repatriation of foreign profits, it has made sense for them to continue in their old ways. But this year since the dollar index has been on a bumpy upward slope from close to 70 up to 80.5 at present, the perceived need for currency hedging must be much less than it was. So the rational thing for them to do with short term cash would be to leave it in short term Eurodollar denominated funds in foreign banks. The only reason they wouldn’t that I can think of is perceived risk of Euro and London bank failures.
Now in the US you can get “T-bill only” money market funds, and commercial funds are now “guaranteed”. (It does scare me to think that M3 might be coming home, and the Fed will have to start counting it all, afterall).
I think Europe has no alternative but to match the guarantee. So that raises the question if tiny Switzerland really can back the huge Swiss banks, or even if mighty Germany can back theirs with the much lower reserve requirement that they allow their commercial banking system.
Trichet has already said it’s not the job of the ECB to back the banks since the ECB cannot issue government bonds to fund it. Trichet says bailouts are to be handled by ECU governments. So here is how we see if the ECU/ECB structure can survive.
“It’s good to be King”…but still crappy to be a peasant in any of the King’s lands.
aybe the U.S. can do what no country has ever done before – expand its national debt far beyond any foreseeable means (short of massive currency devaluation) of repayment, sustain continuous huge annual fiscal and trade deficits (which no short-term recession is going to help for long), pay for multiple wars around the planet in the role of World Policeman, and provide fully-paid-for retirement and medical benefits to a growing segment of its population – without its currency losing its role as the world’s reserve (with all the interest-rate and inflation-fighting subsidies that brings).
Maybe.
The only scenario that makes such an outcome plausible is the total crashing of the European, Japanese, and Chinese economies while the American economy somehow “muddles through.”
It didn’t work for the Pound in the period from 1914 to 1933 (the ups and downs of which were very similar to the ups and downs of the dollar now), but the English then were as confident as many Americans are now.
In days of yore, our forebears ancient had another name for a liquidity crunch – a shortage of money. Supply and demand: shortage, high price.
Old-style panics had another natural consequence: high interest rates. Shortage of present money, surplus of future money. Libor is feebly attempting to recapitulate this ontology. See also Wells Fargo’s 9% rate on jumbo loans. (Murray Rothbard’s 1962 dissertation on the Panic of 1819 remains highly readable.)
A natural, unhindered contraction in this system would make the Panic of 1819 look like a mouse ran across the carpet. The rise of USD/EUR is the mere ghost of a shadow of a classic shortage of money. Fortunately, there is an arterial firehose of cash pumping out of Washington.
The long-term inflationary danger reflects the difficulty of clamping this artery. When a nominally private, if government-insured, financial system is responsible for the chronic excess of consumption over saving, deflation and austerity remain conceivable. But temporary programs tend to become permanent. When Washington starts buying “other loans” galore – commercial paper, now? – and becomes the lender of first resort, the hemorrhage starts to obey the rules of government. The fear of a clot disappears. And markets, being efficient, reflect this change immediately…
In other words, I suspect that a great deal of the confidence in the post-WWII OECD financial system – dollar and euro alike – is provided by that system’s vast, but theoretical, capacity for thermonuclear deflation. Its managers need to keep that threat credible, while not allowing it to actually happen. Unfortunately, their bluff is in the process of being called.
This is the synthetic dollar short theory that Richard Russell was prematurely worrying about a couple of years ago.
http://www.bullnotbull.com/archive/dollar-2.html
-Mike
Fifty million Americans receiving social security retirement benefits fortunately will not directly be affected by the economic crisis. Their monthly checks will continue arriving while their bank accounts are insured by the FDIC. The presidential election has little meaning to a retired person under those safe circumstances. Both candidates despite their perception are middle of the roaders and will not interfere with the financially secure lives of old timers.
Mike: The “dollar short” explained in detail in this 2006 article is exactly “wrong think”, when matched up with both prior and current events, IMO.
In 2005 we had the Fed tightening from 1% up to 5% eventually, while the ROW still had rates low from 2002-2003 levels. This lead to large interest rate differentials which is the primary driver on currency valuations in the absence of any other weird shock type things going on. And the interest rate effect happens very quickly because the interest rate futures market catch on to sea changes very quickly and drive the currency markets far in advance of the actual completion of central bank cycles.
That’s why the dollar stopped going down this spring about 1 day after Bernanke finished with his emergency rate cuts. The futures markets declared the dollar bear party over.
(that one caught me by surprise. because I was hoping to collect some non-US interest for a while. Rats. Gave it back and more in principal.)
But I have another one for the flight from risk theory. London banks are always the 3rd or so largest holder of US treasuries. Everyone knows Englishmen don’t have that much money, and London banks are acting for their Middle East and possibly Asian clients.
So what if fear of bank failure makes this cash come to America and get their treasuries straight from the insured teat of US institutions? Brad can watch for this in custodial holdings, but this may not even be all official central bank money. A lot may be sheik private accounts. Swiss banks could have a similar problem.
Why is the US$ rising? Try this: INTERVENTION. There was a time when US authority elites would look down their noses at those unenlightened foreign currency interventionists in Japan, China and elsewhere. How things have changed. Here is how I see it playing out…
(1) There is a real possibility of massive US$ collaspe.
(2) Such an event would be akin to setting off a nuclear bomb in the global financial markets.
(3) Fed decides to act and recruits its foreign central bank counterparts.
(4) Unprecedented (in terms of size) swap agreements are arranged: US$ go to foreign central banks and foreign currencies are sent to the Fed in exchange.
(5) Foreign central banks sit on the bulk of those swapped US$.
(6) Fed uses swapped foreign currencies to support the US$ — massively buying US$ in foreign currency markets.
(5) US$ goes up, armageddon is averted for now, and everyone wonders how such a counter-intuitive move is possible.
(6) Voila — Bob’s your uncle!
monmick:
We have completed up thru step 5 as you described.
Step 6 is the mama of all conspiracy theories. That would put euros in the hands of foreign commercial banks, lowering the euro and being very inflationary and also really increase the Libor rate due to lack of dollars circulating in europe. Thats the opposite of what US and ECB officials say they want.
And there is supposed to be $350T of variable rate loans tied to LIBOR globally. Tho I still chuckle at the thought of the US subprime borrower selling off his stock portfolio to pay his variable rate subprime mortgage. Negative net worth is the bulk of the problem.
Then the Fed is supposed to unwind the swap by giving foreign central banks their euros or whatever back directly, as an aid to book keeping I imagine. That’s supposed to happen next spring sometime.
Not to say they wouldn’t do this by accident, I guess.
Here’s how the eurozone stress test is going. Much as we hate the good buddy relationship between the treasury and fed here, always pushing our problems out into future, the ECB/ECU/reality of separate sovereign governments seems to hamstring crisis management there.
The Euro gapped down to 1.36 this evening. We could see big banks blow and maybe even whole countries. Imagine the sovereign debt free state of Italy ! Viva la Lira !
Sarkozy Fails to Unite Euro Zone for Bank Rescue Effort
Sunday, 05 October 2008 23:34:45 GMT
Written by Ilya Spivak, Currency Analyst
French Prime Minister Nicolas Sarkozy has apparently failed in his attempt to fashion a united European policy to the spreading global credit crisis. Sarkozy called a summit of top Euro Zone leaders to discuss proposals over the weekend. The meeting was attended by German Chancellor Angela Merkel, Italian Prime Minister Silvio Berlusconi, British Premier Gordon Brown and top officials from the European Central Bank and the European Commission. The meeting produced little substance, with policymakers agreeing on nominal measures to ease accounting rules, seek tougher financial regulations and weaken enforcement of competition and budget laws (to make it easier for stable banks to buy shaky ones).
Ms Merkel, who had long believed that any kind of coordinated action effectively amounted to Germany footing the bill on bailouts in other countries, clearly chose to go it alone today with an announcement that the German government would insure private savings accounts. As of the end of 2007, this amounts to 568 billion euros ($772 billion). This comes even as German authorities were coordinating top banks and insurers for a 50 billion euro ($68 billion) bailout plan for commercial property lender Hypo Real Estate Holding AG. Hypo is Germany’s second-largest property lender.
Here’s another FX look at all the majors. Nice long term charts, and some fundamental thoughts plus a little tech analysis by Uncle Fibonacci.
“Monthly Forecasts for Euro, US Dollar, and Other Forex Pairs”
http://www.dailyfx.com/story/special_report/special_reports/Monthly_Forecasts_for_Euro__US_1223064513342.html
Good discussion. there seems to be a broad consensus that a shortage of dollar liquidity in europe has contributed to the dollar’s rally. Discord among Europeans over how to respond to the crisis seems a factor too — tho you could argue that this is no worse than the discord in say the US house of representatives over the right response.
One housekeeping point: for the first time since this blog migrated to the CFR site, it is starting to receive comments from those who believe in certain conspiracy theories about the world. This is a blog that is very data driven, and the comments have historically been a place for serious discussion. Even learning sometimes. I have no intention of seeing its character change. Certain types of comments will consequently be deleted.
Finally, for those who have had trouble with the anti-spam numerical protection (which works well by the way), I sympathize. I have lost comments too. Try to keep the comments short — as the addition question can change while you are typing.
Aren’t borrowers and leverageurs around the world effectively short hundreds of trillions of dollars? Now suppose that because they can no long roll short-term loans that are payable in dollars, they must come up with actual cash dollars to retire those loans. Voila! A short-squeeze on the dollar is triggered. My essay on this subject, written several years ago, is archived at gold-eagle.com and at my own web site, rickackerman.com. It describes how an intrinsically worthless dollar could be squeezed to absurd heights. We’ll know soon, since my technically derived target for the Dollar Index (DXY) is 84.96, and if the squeeze doesn’t end there, bulls are going to romp. Actually, the fact that there aren’t any dollar bulls suggests why a short-squeeze unwind could be happening in the first place.
Rick,
Well, that would be a theory…but what about Voila, I default?
The definition of being bankrupt is when you can no longer borrow to pay off your debt. That truism has withstood the test of time in any currency, even lira and wiemer marks.
I think the 85 target on the dollar is doable, but it’s the flight from risk that will do it.
By the way, the COT figures by FX indicate 100% dollar bulls at the present time. There are no dollar shorts.
Brad’s probably asleep now, so I’ll see if I can get this one thru.
I can’t overstress the importance of the eurozone stress test at this time. There has been a long standing opinion, even among paid economists, that if anything goes awry in the ECU the political/CB structure can’t respond in ways we know in the US, and the well known schism between stronger and weaker countries in the union will be under pressure and may come apart.
For instance, they may decide to spin off Italy and designate it as a “bad bank”. Italy will do what “bad banks” do and default on their creditors.
I know I’m the only one here that cares about Italy, but I’d like to point out that Italian government debt is only about $1.75 Trillion USD (and falling).
That means the Treasury couldn’t buy them on a Tuesday or Thursday, but would probably wait for a Sunday, which seems to be reserved for the really big money deals.
I know some of you are wondering “Why should we?…. we just gave the Big Three automakers $50 Billion, and maybe Ferraris and Lambos are cooler than green vehicles, but California Cabs are better than Chianti.”
My answer to that is “Someone will have to buy Italy. Period.”. So why not us???
So I guess what I’m getting at is would all of you please write your Congressman (including Dave C.) and urge your Congressman to please buy Italy when it becomes available.
Thankyou.
Dear Brad,
Your topic is quite interesting. In the early stage of a financial crisis there is a severe lack of liquidity; this pushes short-term interest rates up; and with credit crunch, some business or financial institutions have no access to liquidity (collateral is not good, rating issue, etc.). In this event, and if they have assets in their foreign affiliates or can borrow abroad, they repatriate them: There is a short term capital influx, driving up exchange rate (this case the dollar). I think the litterature call this the Ahston effect.
I would imply that european banks are fine, but the ECB has injected tons and tons of euros, so perhaps the Ahston effect is smaller in Euro area.
Best regards
FC
“(1) an increased amount of FX carry trades began to be funded in USD over the course of last year; ”
Brad, a long time ago (or so it seems) I posited that USD would become the short side of a new carry trade. You told me that unlike Japan, the US was not a net saver so could not become a funding currency. How do I square this circle?
“Someone will have to buy Italy. Period.”
Well, if I can get that villa in Tuscany, I’m all for it.
a:
Well, we’ve now got someone with dot.com experience sniffing out the bad loans in America, so things can only get better.
++++++++
Reuters
Paulson to name adviser to oversee U.S. bailout: paper
Monday October 6, 7:30 am ET
PHILADELPHIA (Reuters) – Treasury Secretary Henry Paulson is expected to name Neel Kashkari to oversee the $700 billion program to buy distressed assets from financial institutions, The Wall Street Journal reported on Sunday.
ADVERTISEMENT
Kashkari, a Treasury assistant secretary for international affairs and a former Goldman Sachs banker, is expected to be named interim head of Treasury’s new Office of Financial Stability as early as Monday, the newspaper reported in its electronic edition.
Kashkari, who headed Goldman’s information technology security investment banking practice in San Francisco before joining Treasury, has been advising Paulson on a variety of issues since his nomination in November 2007.
In his new position Kashkari would oversee Treasury’s effort to buy bad loans and other distressed securities, the newspaper reported, citing unnamed people familiar with the matter. A Treasury spokesperson was not immediately available to comment.
(Reporting by Jessica Hall; Editing by Clarence Fernandez)
t — you were right and i was wrong!
the us had very generous creditors, so inflows to the US (notably from central banks — see my post last week with the magnitudes) exceeded the current account deficit, leaving some funds left over to finance outflows, including “carry” related outflows.
Ah OK, thanks. I’ll take myself more seriously in future
Presumably less creditor inflows might start to unwind that carry trade a little and act as a brake on the dollar weakening that one might otherwise expect.
Simple explanation:
US banking system can always be bailed out (by issuing governement debt, and/or inflation -FED intervention, which will dilute the value of your assets, but better than nothing). EU banking system: hard to think who will rescue it – Deutsche Bank assets=80% of German GDP (can you think of a government selling to the private sector a similar amount of govmt bond?s; ECB could purchase these bonds: will it ever print more money to rescue banks? and WHICH banks? German? Italian, Dutch?….)
My demand for US dollars is a demand for US dollar deposits. I’ll put my money where deposits are (at least to some extent) safer…
Fernando,
Google seems to indicate a spelling error – I think you mean Ashton effect. Not to be confused with Ashton Kutcher. But a nice catch!
just follow the benjamins…US assets are soo steeply discounted now, foreign investors are buying. even with crappy interest rates (which is generally the barometer for currency pricing)
Brad,
The dollar has been rallying because the global banks who purchased these massive amounts of CDOs etc…(long dollar) also shorted the US dollar as a hedge. These banks have been covering those gigantic shorts as the mortgage products experience the great unwind. This is the major part of the current repatriation of dollars. It will not last forever, as you know.
The reasons for the crisis and the dollar rally are political. That’s why they don’t make economic sense.
The crisis has been engineered over the last 5 years or so. The US deliberately increased it’s debt, and the boom has been fostered.
In the UK we have doubled our share of US debt over the last 12 months despite there being warning enough to dissuade the most naive investor.
The media shows images of runs on Northern Rock, or people carrying boxes of personal posessions… Governments could have gagged this.
Is the dollar rising because people with a lot of money have finally worked out what is going on?
The US intends to default, and it intends to get as many western nations as it can in the same boat.
Only WW2 finally cured the great depression.
And now another countless million bodies will have their fat converted into currency to dig us out of this one too.
Buy dollars, or renmimbi if you’re clever.
When the adjutant comes, tell him your sons moved to botswana.
[...] o fato de que os EUA estão num buraco miserável e o dólar só sobe? Seus problemas acabaram! Eis aqui um post, enviado pela grande especialista em finanças internacionais Mariana, que nos explica a vantagem [...]
[...] The worse the US does, the better the dollar does … [...]
[...] The worse the US does, the better the dollar does … [...]
[...] The worse the US does, the better the dollar does … [...]
[...] heading toward a sustainable market level. The financial crisis drove the dollar back up because traders had made enormous bets denominated in dollars, and they had to buy dollars to unwind those positions. When the unwinding is finished (that is, [...]
[...] The worse the US does, the better the dollar does … [...]
[...] The worse the US does, the better the dollar does … [...]