Tuesday, October 6, 2009

The Fall of the Dollar & The Next Bubble

Robert Fisk reports that a host of countries are looking at replacing the dollar at the currency of international oil dealings with a basket of currencies, including gold. This would further reduce demand for the dollar and contribute to an even weaker dollar internationally. This will strengthen the growing carry trade built on low interest rates at the Fed.

The dollar, already plumbing its lowest levels of the year, is expected to continue to weaken even as an improving U.S. economy eventually leads the Federal Reserve to unwind more of its liquidity-boosting programs.

That's because the U.S. currency has increasingly been at the center of a so-called carry trade. With interest rates effectively at zero in the U.S., global investors seeking risks and higher returns are increasingly borrowing risk-free dollars to invest in higher-yielding currencies and assets, such as stocks, commodities, and emerging markets.

So the Federal Reserve, trying to boost the US economy, is practically giving money away to investors. But a weaker US dollar may be welcomed because it will help this carry trade.

The U.S. may “welcome” carry trades in dollars as returns overseas flow back to American investors, Credit Suisse Group AG said.

High returns generated in other countries will help the dollar maintain its status as the world’s reserve currency, even as the greenback weakens, said Hiromichi Shirakawa, chief economist at Credit Suisse in Tokyo.

“A weak dollar should be welcomed, since it signals a recovery in the global economy and financial markets,” Shirakawa said by telephone today. “The U.S. will likely welcome dollar carry trades.”

In a carry trade, investors borrow in nations where interest rates are low and buy assets where returns are higher, profiting from the difference. Benchmark interest rates are as low as zero in the U.S. compared with 3 percent in Australia and 2.5 percent in New Zealand.

But wait, Credit Suisse argues that the carry trade will help secure the dollar as the world's reserve currency, while the first article argues that the shift away from the dollar as the currency for international oil trades will indicate a move away from the dollar as the world's reserve currency.

What happens when both trends combine?

You'll have dirt cheap dollars from the Federal Reserve practically giving money away. You have the dollar with less global credibility as countries move away from using it as the world's reserve currency. The carry trade will still be there but the demand for dollars will drop. More dollars, less demand, mix, and you get an even weaker dollar. Rinse and repeat.

And the response from the big corporations and global investors like Credit Suisse?

Everything is great! Returns on international investment (speculation) are the only way for the US economy to pull out of the economic crisis, they'll say. Keep other countries more money, don't worry about investing in America. You Americans have moved beyond manufacturing and actually making things, just focus on giving us your money and everything will be fine!

The result, of course, will be the next big asset bubble. With the rise of a global middle class based in Asia (primarily India and China) the need for expanded extraction of natural resources will turn to South America and Africa (and perhaps the Arctic). While the carry trade overall includes international investments, the concentration will be in natural resource extraction in the Southern Hemisphere. China is already looking at Africa for oil, for example.

And what will be backing up this asset bubble? Just like the last housing bubble it will be the US government. The one thing the dollar will still have going for it is the backing of the US government. Not because the US government is so trustworthy, but because the US military will still have the ability to back up US investments. A populist uprising threatening key oil investments in West Africa? Call in the Marines. The more our financial system is tied up in the international asset bubble, the more our military will be called on to play the role of the world's policeman. Which will just further contribute to the bankruptcy of this nation.

This isn't just the fall of the dollar, this may well be the fall of the United States.

1 comment:

  1. Good analysis. I have the same vision as you regarding the dollar. However, I think the dollar will go up mainly because the dip of China in the near future, before its bubble burst. Here is the link to my blog on US dollar. You're very welcome to read and leave your comments.