Tuesday, April 01, 2008

Dollar headed for a decline?

Late last year I made some observations about the economic future and some of them are panning out as expected. As mentioned pressure on US dollar is considerable. Mark Thoma in Economists' view linked to Martin Feldstein's falling dollar article.

I was amused by the article and commented on one particular statement. Here it is:
"Despite the recent dollar decline, America’s trading partners still have large trade surpluses. ... So the more competitive dollar is not causing fundamental trade problems for America’s trading partners."
Whoa! While I agree that US dollar needs to correct itself to more competitive levels, the above statement is discomforting. As Alex mentioned if dollar decline was for real US trade deficit should have increased. Thats not happened because "almost" all trading partners have currencies pegged (overtly or covertly) to the dollar. Hence dollar decline takes all this basket of currencies lower.
The "almost" in above statement refers to oil! Oil is delinking from USD denomination. Other commodities are catching onto this idea. And all US trade partners need oil and commodities. As oil and key commodities move relative to dollar you will see more pain for US and trading partners, creating an incentive to stem the currency depreciation.
Now comes the main dilemma - as these countries move away from dollar peg - their reserve start losing value. At the least $ 1.5 trillion is held in reserves by major trading partners - even a percentage point here makes quite a big contribution to their GDP - so its like rock and hard place situation.
This, to my mind, will put a hell lot more downward pressure on the dollar than has ever seen before!
Though this raises US mfg competitiveness but hits Europe hard in their face. The trading partners' might face crises - and lets hope its just monetary and not a social unrest. (thats why you have something called country risk)
To my mind a stronger USD easing out is much better way out of current mess. Funnily US has an incentive/self interest to devalue the dollar - but doing so will mean push everyone into a deep downward spiral.

This summarises my logic neatly. And I even got a comment reply from Organic George. Here it is:

Organic George says...
Rahul is spot on with his "delinking" comment.My company trades commodities from all over the world. We understand that the Euro is the new dollar when it comes to pricing.

I guess most of the Irory tower crowd is waiting for one of their own to write a paper to prove it.

It feels good to get a positive response. And its also in the news as Yves Smith points out! I am definitely elated!