The STATE of the DOLLAR and the Black Swan Response

Key News

  • Chinese central banker warns of new Asian crisis China’s deputy PBoC chief Zhu Min warned that tighter US monetary policy could spark a sudden outflow of capital from emerging markets, evoking the 1990s Asian financial crisis. This phenomenon called carry trade in the US dollar is a "massive issue today, It’s bigger than the Japanese yen carry trade 12 years ago," he said. However, if the US (Fed) were to tighten its lax monetary policy, making borrowing more costly, funds could then flow out just as suddenly from emerging markets, back into the US market. This could cause a collapse in emerging markets’ currencies, and spark a repeat of the 1997-1998 Asian financial crisis. (Telegraph)
  • Soros warns gold is now the ‘ultimate bubble’ (Telegraph)

Quotable

“Implicit in the activist conception of government is the assumption that you can take the good things in a complex system for granted, and just improve the things that are not so good. What is lacking in this conception is any sense that a society, an institution, or even a single human being, is an intricate system of fragile inter-relationships, whose complexities are little understood and easily destabilized.”

                             Thomas Sowell

FX Trading – The STATE of the DOLLAR and the Black Swan Response

Our Federal Reserve has chosen to leave interest rates unchanged again as the path to US recovery is still dependent (perhaps psychologically) on cheap money. But yesterday’s monetary policy announcement reveals that there is now a lone dissenter who’s not happy with the current rate policy.

To be sure, the individual dissenting is obviously not China’s deputy PBOC chief Zhu Min (See ‘Key News’ section above.)

And there’s this from Reuters:

“The European Central Bank, the Bank of England, the Bank of Japan and the Swiss National Bank, as well as the central banks of Canada, Australia, New Zealand, Mexico, Brazil and Sweden said they will let their dollar "swap" arrangements with the U.S. Federal Reserve expire on Feb. 1.

“Demand for the dollar swap lines, through which the U.S. Federal Reserve provided billions of dollars to overseas financial firms via foreign central banks, has fallen dramatically as market conditions improve around the world.”

Hmmmm, is the exit strategy beginning?

I guess it depends which exit we’re talking about – the exit from easy money or the exit from the public spotlight.

The announcement yesterday included strong words on recovery, low inflation and continued strengthening. So, exit from easy money? Slowly.

Ben Bernanke has been on the hot seat ahead of his possible reappointment to Fed Chief. Critics say he was largely responsible for letting the crisis come about; he actually steered us into the crisis. Proponents feel he has kept the economy from going over the cliff; he is the one to see this recovery through.

From www.nakedcapitalism.com:

“The explanations for its actions can only support one of two interpretations: that the Fed was a chump, taken by the financiers, or a crony, and was fully aware that it was not just rescuing AIG, but doing so in an overly generous way so as to assist financial firms in a way it hoped would not be widely noticed or understood. The problem with this sort of back-door subsidy, aside from its dubious propriety, is that at best, it’s sorta random (who benefits isn’t necessarily who is in most need or more deserving of help, just who happens to be lucky enough to be associated with AIG train wreck), and at worst, it rewards stupidity and duplicity.

“For the Fed, if it was mainly engaged in “Fed as crony” behavior, that bodes ill for the central bank’s future, since it means it has been lying to the public as to why it did what it did. As investigators keep digging, for they will be certain to find evidence that the various explanations that the Fed has given for its actions will be at odds with its internal debates. If you think the Fed’s reputation is bad now, just wait to see what happens if it emerges that it was engaged in deception.”

Oooooohhhh. So, exit from the public spotlight? As quickly as possible.

Maybe that’s part of the reason for the expiration of FX swap arrangements between the Fed and global central banks. After all, that move at the height of the crisis was viewed as “necessary” to get financial markets functioning properly again, when in hindsight it looked more like the Fed bailing out the world (rather than focusing its resources on US-centric problems.)

I discussed Europe’s need for this Fed maneuver back on December 10th in Currency Currents, citing this excerpt (among others) from a Bank of International Settlements report:

“The frequency of rollovers required to support European banks’ US dollar investments in non-banks became difficult to maintain as suppliers of funds withdrew from the market. Banks were thus forced to come up with US dollars, given their reliance on wholesale funding and short-term FX swaps. Essentially, the effective holding period of assets lengthened just as the maturity of funding shortened. This endogenous rise in maturity mismatch, difficult to hedge ex ante, generated the US dollar shortage.”

Ok, so apparently there’s no more US dollar shortage and things can go back to normal, right?

There exists the potential that this tighter-money posturing, maneuvering, squirming or strategizing by the Fed will ultimately support the US dollar’s value. Well it can’t hurt, considering the overwhelming sentiment that the Fed will opt to inflate away the US dollar.

And that brings me to something President Obama mentioned last night in his little talk.

Littered with awkward contradictions, strong rhetoric pushing partisan ideals, and plenty of trademark off-the-cuff (and off-the-teleprompter) jokes … he mentioned something that jumped out at me.

The US needs to export more of its goods.

Yes, in an environment of deleveraging and belt-tightening and a perhaps permanent shift in consumer attitudes, we need to find something to compensate for that lost growth driver. And we should find something that can be considered positive, helpful economic activity. Emphasis on industry and exports is a good place to start.

But with that the President used the opportunity to wrap back to clean energy and climate change (though he did keep half the capitol from getting restless at this point via a token comment on offshore drilling opportunities).

The idea here is creating green jobs, green technology. Why? Because there’s opportunity there, there’s opportunity for the US to lead the world on this front. Sure, I can’t argue with that.

As the President said, “Even if you doubt the evidence, providing incentives for energy efficiency and clean energy are the right thing to do for our future, because the nation that leads the clean-energy economy will be the nation that leads the global economy, and America must be that nation.”

Yes, but driving an agenda geared around making the public believe we are responsible for climate change is not the right thing to do.

Yes, our politicians should promote a culture in America that focuses on “the right thing to do.” But that doesn’t mean doling out cash to any good-spirited interest that comes knocking. The government is not a charity organization.

A problem with recent government promoting a positive culture (without just tossing around the government’s fiscal clout) is just that so many elected officials seem to be so out of touch with what is the right thing to do. Their hypocrisy doesn’t go over so well when they start talking ethics et al.

That’s too bad. I digress.

If energy efficiency and clean energy make sense, the market will deliver such economic revolutions when it makes sense, when it’s feasible. But perhaps what makes sense right now is for the government to address current energy policy and infrastructure that we’re told is so financially inconvenient, as it would be a much easier and cheaper fix than a hasty run into clean energy and “dirty energy regulation” that promises jobs but only guarantees unintended consequences (among which are lost jobs).

But here’s where I was going, regarding exports …

I ask: Does the US need a weaker dollar to be competitive on the export front?

I answer: No.

Two reasons:

  1. Part of the aim in revitalizing manufacturing and exports would be to produce goods in the US that aren’t being produced elsewhere. This means items related to or utilizing the research and development advantages the US holds over other export heavy economies.
  2. We need to draw in capital to bolster our efforts on this side of the economy. A country with a weak currency is not an appealing destination for capital. And without this capital formation it is hard to make the requisite investment to spur on a sector that’s gone cold in recent years.

As mentioned, our President recognizes this. He also recognizes the need for deficits to be eliminated. The United States is still an economic superpower and possesses the tools necessary to stay an economic superpower.

Now, if only the government can stay out of its own way the dollar may stand a fighting chance.