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.

RD

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!

Asset prices rising - Is trouble brewing?

There are reasons to believe that "investor demand" is driving asset prices through the roof. The "investor" crowd dynamics and the wealth they bring to this party may be acting as a self-reinforcing mechanisms at the core of this increase. If this party has gone on too far then we are in for trouble. A really big trouble.

Invested - appreciated - invested more!
This cycle has continued in almost every globalized economy. The increasing returns from the initial run of this cycle did bring in lot of new investors. The cycle, luckily, kept going enriching investor class substantially. This brought into "investment focus" various "asset classes" - like commodities, real estate, currencies etc. The cycle kept turning till about June 2007.

The last buyer - Where art thou?
Typically all investments terminate with end-user or what we can call the last buyer. Road investment look for the car /truck driver - mall investments look for the shopper - and houses look for the person wanting to stay.
The real estate sector, typically, is the first to look for last buyer. But there we had some interesting toxic concoction brewing - with easy credit flowing into the sector. As the sub-prime crises unfolded last year - the real estate sector finally started looking for the last buyer. It didn't find any.
The reality dawned upon the masses that "real estate" was priced too high for the real buyer. Based on current prices the real buyers will have to slog for many years before they can make any significant impact as "last buyers".
This is probably true for all "asset classes". Real estate (residential and commercial), stocks, bonds, non-agri commodities, derivatives across the globe are at the vortex of this hurricane. These asset classes have experienced tremendous upward force. The asset classes at the periphery - agri-commodities, are beginning to feel the force putting upward pressure on inflation - particularly food prices.

A Quick conclusion
If the hypotheses is true we are in for a particularly long painful period.
Even most powerful hurricane drops the things it throws in the air. So will prices drop - in real terms - either through inflation shooting up making this new wealth worthless or prices will deflate to a pain-point.
The most dramatic inflection point will come, if at all, within two quarters where large money will take sides on either possibilities - anticipating a killing. Let us brace for impact.
Meanwhile - we will look at what may have caused this in a little more details - and like always only hypotheses.

 

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