More On Asian Currencies

Damn... and I thought I could get away with my flimsy comments on currencies ... along comes a regular learned reader in Hisham, an obvious economics research guy somewhere.

What's interesting was that he figured the MYR is not really tracking the yuan but rather keeping in step with the SGD - how I wish that was the case man ... maybe the relationship held true for 2-3 years ago but certainly not the past 10 or 15 years. There is no possible way we can afford to keep in step with SGD noting the huge structural differences in the industries' revenue base and margins achieved.


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hishamh to me

show details 9:29 AM (53 minutes ago)

hishamh has left a new comment on your post "Geithner Could Label China As A Currency Manipulat...":

With respect, I don't think any of the Asian currencies are really much out of line. Some experts do think the Renminbi is as much as 40% undervalued, but the range of estimates is incredibly wide - Goldman Sachs for instance thinks if anything the Renminbi is slightly overvalued. It really depends on the model used to measure misalignments.

The widest misalignments tend to come from current account based evaluations, which ignore stage of development and is also highly normative (i.e. depends on the researchers' prejudices). Econometric based models tend to show much smaller undervaluations, and a price-level based model, which accounts for the level of development of a country, shows very little undervaluation at all.

I'm wondering what the reaction will be next month as China is reportedly going to report its first monthly trade deficit in decades. BTW, factually, HKD is not on a fixed peg but a currency board, which is a very different animal (essentially Bernanke is running HK's monetary policy).

Using the IMF methodologies, SGD is undervalued, as is the MYR. But the IMF assessment IMHO has a serious flaw, because they heavily overweight the US and underweight Asia in calculating the effective exchange rate indices, which biases misalignment measures towards the USD and away from currencies of other trading partners.

In Malaysia's case, the US trade weight used is double the actual, while MY-SG trade weight is a fraction of the actual (ASEAN currencies are lumped together, and the trade weight is something like only an eighth of the real trade share). Using a more balanced weighting scheme shows that in the MYR case at least, the currency is moving within a normal trading band around its long term equilibrium value (about plus-minus 5%).

2nd BTW, the IMF's latest country report examined BNM's currency intervention statistically and didn't find any evidence of manipulation of the MYR level. My own investigation into the matter suggests that if anything, the MYR tracks the SGD, not the CNY and nowhere near the USD. Given the relative development paths of the two countries and the long standing depreciation of the MYR against SGD, it's hard to argue from the empirical evidence that BNM is surreptitiously leaning on the MYR at all.

Taken all together, I would argue that most surplus countries don't have undervalued currencies at all - it's primarily a USD problem. The 30% depreciation of the USD since 2002 is nowhere near enough, as that was started from a point where it was already highly overvalued. All this brouhaha is a way for the US to get away from having to bear the adjustment costs of reducing global imbalances. China's position is understandable and I fully support it. It's their problem, but they want us to pay for it.

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China returned to a quasi peg against the USD in 2008, meaning that, as the USD appreciated as the world suffered a liquidity crisis, so did the RMB. However, with the USD depreciating in 2009, the RMB did as well, despite the divergence in the two countries' growth outlooks. Given Chinese productivity growth, the RMB may be undervalued.

John Williamson and William Cline, Peterson Institute: Chinese productivity growth has outstripped the pace of appreciation of the RMB, meaning that the renminbi remains undervalued. According to the fundamental equilibrium exchange rate (FEER) model, the RMB remains about 20% undervalued on a trade-weighted multilateral basis, in real effective terms. A 40% appreciation against the USD is needed.

Goldman Sachs believes that the renminbi may be near fair value, based on relative prices and productivity. According to the Goldman Sachs Dynamic Equilibrium Exchange Rate model, the renminbi was no longer significantly undervalued in Q1 2010.

Helmut Reisen of the OECD assesses the renminbi's valuation based on the Balassa-Samuelson effect and finds it is only undervalued by 12%. Part of the undervaluation of China's currency is due to the fact that non-tradable goods are relatively cheap, mostly because of lower wage costs. However, there will be a convergence as China's productivity in traded goods rises. Monetary restraint and lowered corporate savings would accelerate the convergence. Despite large FX intervention by Asian central banks, most Asian currencies will continue to appreciate in 2010 due to the global carry trade (Australia, New Zealand, Indonesia, Philippines), high commodity prices (Australia, New Zealand, Indonesia, Malaysia) and strong equity inflows (Indonesia, India, South Korea, Taiwan), though smaller current account balances (India, South Korea) might limit appreciation pressures.

Appreciation of the Chinese renminbi will be delayed, or so Beijing would hope for, until export recovery is certain, therefore delaying the pace of appreciation of other Asian currencies that closely track the renminbi. Countries like India, Indonesia, Singapore and South Korea might allow currency appreciation to contain import inflation.

While capital inflows into the equity and debt markets might continue to support the MYR in 2010, movements in the currency will be determined by the central bank’s FX intervention and the current-account balance. The upward trend in the ringgit against the U.S. dollar and the revival of capital inflows into the equity market have increased central bank intervention in the FX market to support exports.

Central bank intervention in the FX market will remain dominant until exports and global commodity prices recover, and China allows the renmimbi to appreciate. Large FX reserves and external surpluses are a plus to deal with export contraction and weak capital flows. Trends in the USD and Singapore dollar will also be important determinants of the MYR's movement. In 2008, the central bank intervened in the FX market to protect the ringgit from sharp depreciation amid capital outflows.

In May 2009, the ASEAN+3 countries agreed to increase the FX reserve pool under the Chiang Mai Initiative to US$120 billion to allow members to defend their currencies. They also eased restrictions on accessing the pool.

In February 2009, to promote bilateral trade and investment, the central banks of Malaysia and China established a US$11.12 billion currency swap arrangement for three years.

p/s photos: Angelababy Yang Wing

USD , Gold & Sarah Palin

The media have been making a big fuss on the surge in gold price above $1,000 and on the demise of USD over the past few weeks. Just like my opinion of Sarah Palin, I just shrug my shoulders and ask "so...". Why are we acting as if these developments are a big shock to the system??? Its not, to the general investors, a weaker USD and a higher gold price are what's needed to bring the global economy to an equilibrium. Its only the papers, magazines, business dailies and business networks that have you thinking that these developments were highly surprising and "unanticipated". I guess these people have to sell papers and advertisements, hence they yell through their headlines: "Obama Comes Under Fire As Falling Dollar ...", " "Gold Prices Goes Off The Charts ...", etc...

There is nothing new. If anything, it shows that the global finance paradigm is realigning itself quite well. You cannot have such a huge credit and leveraged implosion in the US and parts of Europe without taking away some of the "wealth" from these countries. You cannot always ride on the fact that you are the reserve currency and everything will be business as usual.

Just look at the printing press at work in the US ever since Greenspan took over, these notes are not backed by anything but the nuclear warheads and flying bombers. Granted we need a superhero to safeguard democracy in the global platform, and its a price we all have to pay, but there comes a time when less and less will want to hold USD papers, and the day is now.

China and some Asian leaders have been warning that the US indebtedness cannot be allowed to go on unchecked. Now the US have been awaken to the fact that those are not hollow warnings at all. While I think the USD will still be the reserve currency, it is well on its way to losing a large part of its "premium".

Unbelievably, CLSA invited Sarah Palin to the big annual conference in HK. Gee... why listen to that woman who has not traveled out of Alaska or the US. What kind of value add commentary does she bring to the table? I am not even going to quote what she said about the USD weakness and gold price (she did say something) as ... seriously folks, I am being nice here, she is nowhere qualified to contribute with any sense or participate in this discussion. I'd be better off talking to my taxi driver who can give me a more nuanced view on these issues.

In fact, what is so bad about a weaker USD??? Most Americans don't really travel overseas anyway. They have almost outsourced everything they can to China, Brazil and India anyway - they don't really make anything anyway. A weaker USD will boost the competitiveness of US companies though and make their stocks a lot more attractive.

The weaker USD is basically a long overdue result of Fed's printing press. Its always the central banks that causes economic bubbles, not the consumers, not the banks... they only behave badly when given too many toys by central bankers.

The USD weakening is good for the majority, it shows that if you messed up your financials, you get punished. We need to push the USD down another 10% over the next 6 months so that we can force them to deal effectively with their indebtedness. You cannot just pump $1,000 bn over the last 12 months and pretend that all is fine.

Gold price is merely reflecting an inflationary hedge that many see is coming over the next year or two. Like it or not, higher gold prices actually is good for stock markets, because commodity prices will be higher as well as most assets. Its a reflationary cycle, much like pumping hot air into a balloon, all assets go up, including stocks. Yes, we are basically remaking a new bubble. Still early days though, maybe another 12 -24 months before we get pricked - key, watch the global interest rates movements.

We need higher gold prices because that means inflationary fears are rising. we need to have inflationary fears because that means that business activity is on the up and/or the reflationary cycle is up and running owing to the fact that the large amounts of liquidity being pumped in by central banks over the past 10 months are now being put to work (i.e. circulating in the system).

We all need a bit of inflation every now and then, you certainly don't want a deflationary or stagflation period (go ask Japan) ... a bit of inflationary fears now is good and needed.


p/s photos: Amigo Feng Yuan Zeng

No Alternative Available For Now To Replace USD As Reserve Currency

Special Drawing Rights have captured the market's imagination in recent days. Behind the scenes, Chinese and Russian officials have harping on it, and the head of China's central bank posted a report suggesting that SDRs should have an expanded role in global finance, including as a super-reserve asset. In a presentation to the Council on Foreign Relations, beleaguered US Treasury Secretary Geithner appeared to some to initially be open to such proposals.

Governor Zhou Xiaochuan. In it Governor Zhou argues that the world needs a new and better reserve currency, one not dominated by a single country, and that it is in the best interest of the world that this reserve currency be created by a body like the IMF.

Many people are unfamiliar with SDRs. Special Drawing Rights were first issued by the IMF in 1969, as Bretton Woods was straining and fears there was not enough gold and dollars, the main reserve assets, were growing. SDRs are a basket of existing currencies. The basket gets reset every 5-years. The last reset was in November 2005. The US dollar accounts for 44% of the SDR basket. The euro's share is 34%, while the yen and sterling's shares are 11% each. The SDR is a basket of existing currencies not a single currency like the euro, but rather more like the old European Currency Unit. The value of the SDR is calculated and posted by the IMF daily. It is currently worth about $1.51.

There have been two allocations of SDRs. The first was in 1970-1972 for 9.3 billion SDRs and the second one was in 1979-1981 for another 12.1 billion SDRs. In 1997, there was a proposal to double the SDR issuance to 42.8 billion (roughly $64 billion). One hundred and thirty one members endorsed the proposal and they had a weighted vote of 77.7%.

Approval requires 85%. The US has a 16.75% vote share, and has not approved the proposal. If there was a signal in Geithner's remarks is was that the Obama Administration may reconsider the US stance. Here is why it is necessary: Roughly the fifth of the IMF members which have joined since 1981 have never received an SDR allocation. Of course that inhibits their ability to participate in the SDR system. Moreover, given the depth and magnitude of the financial crisis and economic downturn—anticipated to be the first time in more than half a century that the world economy will likely contract—an new allotment of SDRs may be compelling.

We have heard these kinds of arguments many times before over the course of the 20th century, and usually in response to a global balance of payments crisis. Is there anything new about this proposal? It looks likely to be a purely political move.

A number of people including Columbia University’s Joseph Stiglitz, are supportive of the idea, arguing that the status of the US dollar as the world’s reserve currency creates unnecessary problems for both the US and the rest of the world.

Most importantly for the US it means that it is very difficult for the Fed to manage domestic monetary policy because the US financial system must accommodate not only conditions in the US but also distortions introduced by the use of the US dollar as a reserve currency, and these distortions can be massive. The most obvious example is the way over the past decade systematic industrial policies mainly in China and East Asia aimed at running trade surpluses and the accumulation of reserves meant that the US economy and its financial and monetary systems were forced to adjust in ways that created large and serious imbalances, which only now are we resolving.

At least four months ago George Soros (and others) proposed an increase in SDRs to help provide sufficient liquidity to arrest the deflationary forces that were growing. Ironically, China and Russia, apparently inspired the by famous speculator, have gone even further.

For one thing liquidity is key, and I think not even the euro – and certainly not SDRs or alternatives to the SDR – can ever hope to achieve anything like the level of liquidity implicit in the US dollar market. For another thing, for a currency to achieve reserve status there must be some systematic way of delivering the currency to central banks and other players who want to acquire it, and the US does so by its ability and willingness to run persistent trade deficits. How will the IMF or whoever controls the SDR create and assign reserves?

A new issuance of SDRs is not the same thing as diluting the role of the dollar. The sums are a pittance, especially given the magnitudes of world trade, cross border movement of capital or the holdings of currency reserves. SDRs have been around for 40 years, but they are not really money. Money, as economists understand it, is a means of exchange, a store of value, and a unit of account. SDRs are not a means of exchange. As a basket of already existing currencies, it might appear more stable and hence a better store of value, but what is the metric? The purchasing power of fiat currencies individually and collectively has generally been eroded by inflation. The SDR is not a fiat currency, but a basket of fiat currencies. For the most part SDRs are relegated to a unit of account for the IMF and a few other international organizations.

Some observers suggest that SDRs are the IMF's money (sometimes referred as paper gold), but that reflects a misunderstanding. Issuing SDRs is not the same as the IMF printing money. The IMF doesn't do that. An increase in SDRs simply boosts each member’s claims on the composite currencies. The IMF is not a central bank.

More specifically, if the SDR is indeed a true reserve currency, and not simply an accounting entry that allows central banks to pretend that they are not holding dollars but whose value ultimately rests on its convertibility to the US dollar, who will determine the global money supply and how do we prevent this from becoming a horribly politicized process? After all the Fed has an interest in seeing stability in the value and use of the dollar, and so it can be counted on more or less to act in the best interest of the reserve currency, but why should anyone care about the value of the SDR over the long term and, more importantly, how can prudent behavior be enforced? More worryingly, if Europe has had so much trouble managing monetary policy among a group of neighboring countries with fairly similar social and economic conditions, how do we manage monetary policy on a global scale?

Perhaps the SDR is a covert way of getting back to something resembling the gold standard by creating a fiat currency with very strict rules about its expansion. If that is the case, the SDR almost certainly won’t last long.

Final thoughts:

a) the ramblings by China was interesting but its an airy-fairy idea at best, its motive is likely to "scare" the US officials to think harder about their macro and monetary policies going forward

b) the move will never happen unless IMF becomes more representative of the global financial system, that could take years of appointments to change the racial and country mix of IMF

c) there are a lot of countries that does not agree with IMF's policies

d) SDR needs to get liquidity to a substantial level before it can be an alternative, that is like asking Malaysia's economy to move into the global top 10 biggest economies in 5 years, possible but improbable

e) a saner proposal will be akin to the Euro currency - it can be started by getting ASEAN members to throw all their currencies into the hat together with HK, China, Japan and India... the rest can join later and the new currency can be called AZO... but even that proposal will be extremely difficult, in fact many times more difficult than for the the European Union/ Euro Currency to be formed because of the various differing political platforms each country has, and that each country basically have to give up on having their own monetary policies - if your country unemployment is very bad, but the rest are OK, there's nothing you can do to your monetary policies to loosen the purse, etc...

So, SDR, a pipe dream...

p/s photos: Lara Dutta

The Vital Signs Are Good, Even Though Patient Is In ICU

There are signs that the financial regulators and leaders know what is troubling the global capital markets. If they know, then we are on the way to properly restoring calm and sensibility. More importantly, it will ensure a properly functioning capital markets - which is still not evident now as many stocks have dipped below way past what is considered as fair value. Its pointless to point out which stocks are worth buying as there are too many to mention. You would be better off to try and see the road signs that say that the root problems are being addressed. If they are not doing that, then we will be in the doldrums for a while. However, I can see two major signs which say we should be on the right path. Treasury Secretary Henry Paulson’s comments that signaled he wouldn’t let another large bank fail, large institutional traders began doubling down on bets that large banks would skyrocket. At a time when almost everyone is deleveraging, several funds were in essence doubling their leverage on one trade. This is essential as the statement indicates that Paulson now knows what a catastrophe it was to let Lehman Brother fail (please read recent posting on Lehman Brother, The Rosetta Stone). That will be as close you can get to an admission of grave fault by Paulson.

The major hedge fund Citadel had a conference call over the weekend and agreed with my take on Lehman Brothers:

3:55 p.m.: “One effect we’ve all seen is about the diversity of counterparties. Given the diversity of counterparties around the world, clearly the diversity isn’t enough to deal with some of what we’ve seen in the past few weeks.”

3:54 p.m.: Lehman’s bankruptcy caused “the greatest dislocation we’ve seen in money market history”

The second major issue is the flight to safe currencies such as yen and USD. But, this is not a currency crisis. This is a liquidity crisis, a growth crisis, a confidence crisis. As such, probably the first step should not be to intervene to save currencies. People calling for their central bankers to protect their currencies are calling for the wrong antidote. At a time like this, you don't need or rather you don't want a strong currency. Look at the OZ dollar, there is no way the Reserve Bank of Australia can do much to stem the reversal of the massive yen carry trade effects. The RBA can only do one thing to protect the OZ dollar and that is to raise the interest rates, which is already crippling in light of the over speculated property market there. What good is it to bump up rates and protect your currency and then find your economy in tatters with property markets there compounding. You would have a graver, and longer term disaster in the works. Better to allow the currency to find its own footing. At current levels, the OZ should start attracting some FDI into property for sure and should see a strong boost to tourism. I mean the OZ dollar is even cheaper than the Singapore dollar now by nearly 10%.

The source of aggressive capital flows into the dollar and yen is emerging markets, and it is the emerging market central banks, flush with dollar reserves, who could take action to stem the market frenzy. Naturally this cannot be allowed to continue, especially for Japan, which needs a weaker currency to prevent a more severe deflation in its economy. Emerging markets “need to act the same way the U.S. and European Union has acted. That will address the root of the problem. However, those governments’ assertiveness is limited by their experience.

Ahead of the Asia Europe Meeting, which began Friday, Japan and other East Asian leaders agreed to establish an $80-billion joint fund aimed at fighting the global financial crisis. Much of the movement into yen and USD can be said to be coming from emerging markets themselves, and that needed to be reversed. The setting up of the "fund" is a good start. More collaboration will go some way to slowly unwind the weakness in emerging markets' currencies.

p/s photos: Deepika Padukone

Wither Dollar

Up until now, the dollar, in defiance of all expectations, has been strengthening against most world currencies. Even commodity prices had reversed their bullish trend. Maybe some of the long speculators on commodity reversed or deleveraged their positions to ride along side the US dollar reversal.

How could the dollar have risen in the face of overwhelmingly negative fundamentals? Some said the dollar had risen because Europe is following the US into recession. But, this proposition is ridiculous. No other nation has been as adversely affected by the credit crisis than America, where the mess had all began.

Some opine that Britain’s weakness is part reason for the US dollar’s strength. Yes, British economy is slowing and its property sector is facing a correction after years of bubble activity. But these are simply convenient reasons but hardly persuasive or convincing.

Deficit intact

Since 2002, the US dollar has lost more than 25% in real terms on a trade-weighted basis (or 28% in nominal terms). One would think that it would have gone some way to reduce its current account deficit, i.e. more competitive exports, lower imports, and a shift in consumer behaviour etc.

Truth is, the current account deficit has barely moved and is still at the 5% level.

According to the International Monetary Fund, a 10% depreciation in the US dollar will improve US’ current account deficit by one full percentage point.

Going by that rationale, the current account deficit should have been halved! Instead, over the period where the dollar lost 25% in real value €“ the US economy had to contend with higher oil prices, stronger competition from emerging countries and persistent war-related expenses.

(PS: A clear example of the US dollar losing 25% in real terms: a Middle East nation selling oil at US$100/b today is equivalent to them selling the oil at US$75/b back in 2002)

Noteworthy is that the US has spent the last 7 years in a silly war. China spent the last 7 years building infrastructure and planning for the Olympics.

Which country do you think frittered away resources, and which one tried to add value to her underlying economy?

The real reason

My prognosis for the US dollar strength is that it’s being engineered by major central banks with the main objective of halting the commodity price uptrend.

The stubbornly rising commodity prices was doing a lot of damage to inflationary figures and curtailing demand.

The Fed and Treasury are fully aware that higher commodity prices will not only curb demand, but will also result in higher interest rates (used to rein in rising prices for goods and services.)

But both these institutions NEED to keep interest rates low to proceed to save the financial institutions in the US.

They need to deal with Fannie Mae and Freddie Mac, Washington Mutual, and a whole host of regional banks.

They need a flattish and low interest rate regime to resuscitate and restructure desperate mortgages. They also need more stability in property prices.

Coincidentally (and smartly enough), a stronger US dollar and the planned bailouts do the trick nicely.

The ECB seems amenable to that strategy as a weaker euro stems the drop in exports. If you were to do a survey, the majority of economists agree that the ECB will not reduce interest rates until the second half of 2009.

That’s because the underlying strength in Europe is still strong and it needs to fight inflationary pressures from the high commodity prices more than anything else.

The jobs market in Europe is also still relatively strong. That scenario does not require a weaker euro.

In contrast, the US economy, continues to worsen. This even after the Fed slashed interest rates and the massive bailout plans for Fannie Mae and Freddie Mac.

The US overnight loan rate is less than half that of the ECB €“ 225 basis points lower. The US has a US$750bil per year current account deficit and rising.

It has huge federal and state budget deficits. Americans save less and spend more than any other people on earth. The US economy has been losing ground especially on the manufacturing side to emerging nations, transferring vital industries to them.

Fed’s deteriorating state

The American banking system is under dire circumstances.

More recently, Lehman Brothers buckled under pressure and filed for bankruptcy. I’m expecting a whole bucket load of regional banks to follow suit.

The Fed has already tainted its balance sheet with US$450bil worth of default-prone mortgage-backed assets from its favoured institutions.

This junk now amounts to almost half of the Fed’s balance sheet, yes the very thing that is supposed to back the US dollar.

In the face of these fundamentals, the US dollar has paradoxically appreciated against the euro, ruble, rupee, yen, real, Singapore dollar and almost all other currencies. How can this happen?

While China has been forcing its commercial banks to hold more dollars, there has also been huge buying, by other foreign central banks, of American treasury bills.

In August, the increase in Treasury bill buying far exceeded that which is needed to offset the huge US trade deficit.

The Treasury bill binge happened right before the surge of the US dollar. Doesn’t this hint of a concerted effort by most major central bankers to cooperate with the US Treasury and Federal Reserve?

The trigger-strategy

Prior to the intervention, most major American, European and Asian institutions held short positions in the dollar.

In order to kick off the dollar intervention, they needed a substantial initial pump. The first pump will be used to massively drain dollars from the world system, in order to forcibly raise its cross-currency value, above the first big stop-loss point.

These stop-loss points are well known to the Fed’s primary dealers.

Once the value was forced to the first major stop-loss point, a massive covering of shorts positions began. It was the biggest short squeeze in history.

The short position in the dollar was so enormous up until mid-July, that after the first stop-loss point was taken down, only minimal additional effort was needed to attack the next ones.

With a little added pressure, stop loss after stop loss is demolished, causing short sellers to desperately scramble to buy the dollar to cover what appears to be an impending catastrophic losses.

At some point, the dollar gained a momentum of its own. People who were previously short, and “stopped out”, decided that the wind was blowing in favour of the dollar.

These opportunists converted their funds to go long on the dollar and short on euros, yen, and so forth.

We are in the midst of this reversal right now, after the major part of the intervention has run its course. The powers-that-be are still intervening, to some extent, but they don’t need to use as much force, and have probably unloaded a lot of the long contracts already, at either a profit, or, at worst, a very small loss.

The carry trade

US Treasury chief Henry Paulson and the rest know that the yen carry trade has been fuelling commodity price spikes (borrowing in yen on low interest rates and investing in higher yielding assets).

They are aware that once the stop-loss levels have been triggered in an “unexpected rise in US dollar”, it would result in a domino-effect of investors closing out their yen carry trade positions.

Most of the funds in the yen carry trade were long in commodities, the euro, the Australian dollar and the New Zealand dollar. All spelt losses in those bets. However, the stronger US dollar also caused some of them to remain long instead in US dollar, even after the bashing they took in previous positions.

In the middle of the week, the dollar tumbled in Asian and European trading as a knee jerk reaction to news that the US credit crunch crisis is far from over, but climbed back up.

The markets have been very much herd-like for most of these twelve months, be it in oil or other commodity prices and similarly in the reversal of the US dollar. There is comfort in flying in flocks especially when the global financial markets are so tumultuous. This is not a period which rewards contrarian views.

Even those with contrarian views would be looking for better entry levels, after taking into account market psychology and sentiment. Now investors not only have to judge based on fundamentals and capital flows but also open interest in major futures contracts on various asset classes to get a gauge.

The dollar’s fundamentals are nothing to shout about. The fall of the dollar is a rational reaction to a massively mismanaged paper currency. When currency intervention ends, people will want out of the dollar.

Printing press

Private manipulation of oil, silver or gold markets is a felony but government intervention in worldwide currency markets is perfectly legal.

The bill for the nationalisation of Freddie Mac and Fannie Mae will add about US$6tril to the Federal deficit.

The US government will be forced to print from US$250bil €“ US$500bil new dollars to offset losses in the next 2-3 years.

In addition, it is likely that another US$500bil or so will need to be printed to bail out the FDIC insurance fund.

According to Nouriel Roubini, about US$1tril-US$2tril worth of “value” will have been removed from the system by those who eventually default.

Prior to the credit crisis, the Federal Reserve balance sheet amounted to about US$940bil worth of treasury bills.

This was the fundamental support for the “Federal Reserve Note” or better known as the US dollar.

That is also now lumped with about US$450bil worth of default-prone mortgage backed securities, thanks to efforts to bail out big banks from their even bigger mistakes.

This leaves the US dollar with less than US$500bil in solid support. Each additional new Treasury bill to support printing more money will tarnish the balance sheet.

Soon, global investors will start shouting that the US dollar is not backed by anything at all. If you are not going to revamp and restructure the economy and consumption patterns yourself, the rest of the world will do that for you.

Nearing the end

It’s really quite simple. There are potential trigger catalysts €“ maybe when investors start to add up the mind boggling funds required to complete the bailouts, or when fellow central bankers decide enough is enough with regard to joint intervention, or when the Fed has to cut rates, or when some critical Mid-East nation(s) decides to drop the peg to the US dollar.

Ultimately, the reserve currency status will only get you so far. Finances need to be shored up. Lehman being allowed to go into bankruptcy and Merrill Lynch giving up trying to stay afloat independently, had probably ended the US dollar uptrend.

US dollar will be on a downward pressure with the Fed having to lower rates in the months ahead, and more significantly, the imminent collapse of many more regional banks in the US now that both Paulson and the Fed’s Ben Bernanke have drawn a line on bailouts (not going to happen anymore).

Investors eager to swoop in on US dollar denominated assets may want to bear this in mind, be it stocks, bonds or property.

photo: Crystal Liu Yifei