Today is the first day of snowfall this year, and as I'm looking outside, the large snowflakes near my window are actually flying upwards. It seems to be defying all laws of gravity.
Just like the US dollar.
The U.S. economy is collapsing, a recession, no, a depression is imminent and the dollar is rising. Whats going on here??
We are in the midst of a readjustment. Err..., slight understatement... what we are seeing is nothing less than the birth of a new international monetary system . This has to be taken in steps, and while the average observer is left baffled by the fluctuation and contradictory trends of asset prices (equities, currencies, commodities etc..), for viewers behind the scenes the market volatility we are seeing is understandable and natural. But the snow has gotta fall somewhere.
It looks like our friend, The London Banker seems to have a good explanation for this current reversal of trends. A very interesting read.
In [very] short:
1) The Paulson plan required hedge funds raised margin requirements from 15% to 35% worldwide. That resulted in a huge contraction in global liquidity.
2) to meet those margin calls, the money flowed back to the US in form of treasuries, raising the demand and price for the dollar and causing a sharp sell-off in funds, resulting in the decline in commodities.
...but what happens when this is over? "Will anyone want to buy dollars when they don’t need them to repay dollar debt?"
The crash of the dollar and another rise of commodity prices is inevitable. Foreign demand for treasuries is falling and with our debt to foreigners over $10,000,000,000,000 (yes thats 12 zeros!!), paying back that money is much more expensive when the dollar is high. There will be a concerted effort on behalf of the US to again depreciate the value of the dollar so it can deflate its debt. Why give our creditors expensive dollars when we could give them cheap ones?
The system will be aflush with dollars, [hyper?]inflation will kick in, and a crash in the dollar will begin. The money has to go somewhere. Since the dollar is the international reserve currency, and in times of extreme volatility most investors just want a safe store of value. But where else can money be stored? Will it flow into Euros? WilI it will flow into commodities? How about other currencies?
Euro and other currencies: There is an unusual lack of commentary and specalation on the future price of the Euro. It seems everyone is afraid to guess which direction it may go. The eurozone feels its currency is still overvalued and is resisting capital inflows which would increase its value. This goes for other large economies around the world as well. Until an alternative systemic solution can be found, the money will have to flow somewhere. My prediction: until we hve a viable alternative, we will see a rise in the Euro and other currencies with a current account surplus relative to the dollar.
Gold: Hedge funds have been selling assets across the board and turning gold into dollars, or at least the paper gold of futures contracts into greenbacks. This caused the recent price decline, but there has been an over 120% rise in the retail demand for gold this quarter alone! Once hedge funds have no more liquidation to do, we can expect gold as a traditional store of value to remain an attractive target for capital. There is also speculation that there could be an official revaluing of gold (to over 10x its price today!!) in order to monetize our outstanding debt and reinflate asset values. Something similar to what happened in the 1930's. Whatever happens, it probably won't happen overnight. Stock up on gold jewelry, and expect prices to rise again rise to record levels as the USD weakens in 2009.
In summary, we can expect the dollar to sharply decline and gold to sharply rise as the financial crisis unfolds. Time-table? Always the most difficult to predict, but if the trends continue, then by early next year we will have already seen some trend reversals.
But what does the mid to long-term future hold? Can the dollar remain the international currency? What form will the new international monetary order take? Who will be the power-brokers? The money-holders? There are several interesting initiatives and ideas on this I'll take up in my next post....
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You're not alone, the rain drops here are falling upwards. The dollar seems to be wildly fluctuating like oil prices. In CA gas is around $2.30/gal down from $4.11/gal in July!!! We were bracing for $5/gal now prices haven't been this low since Bush was still popular. prices in the US is dropping along with consumer confidence and predictions of a dismal holiday shopping season. The warning I've heard is for deflation. The increase of dollars traditionally caused inflationary pressures but I don't know which way direction the storm will go this time. Maybe like the snowflakes defying gravity deflation will hit us when historically inflation should be kicking in.
ReplyDeleteIf the system is crumbling under its bloat, corruption and mismanagement then what will take its place? Will the phoenix that rises from the ashes be a just, equitable and sustainable creature? Or we get another bird of prey in new feathers?
As the gov gets ready to bailout the once mighty colossus Citigroup one wonders if anything is safe. The dollar might be crap but compared to the rest of the world the US still looks relatively stable (for now). When it comes to gold I'm reminded of Warren Buffett talking about how foolish it digging up this stuff out of the ground only to hide it away.
We are in a strange place where the old rules no longer apply and the new rules have yet to be written. The snowflakes are flying up.
FYI, a tid-bit,
ReplyDeleteThe physics behind the rising snowflake is as follow:
Your house is warmer than the cold air outside, so your window will warm that cold air that the snowflakes are lounging in. This warm air rises which pushes the light little snow flakes up.
It's the opposite of what you would feel inside. A closed window may feel as though wind is getting through, but really it is the cold air falling on on you.
I'm an engineer and in now way an economist, but I will attempt a metaphor none the less. I would say, our intent on structuring the world around us can have profoundly unusual effects on the environment.
Cheers