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Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

Win-Win Scenario for the U.S. Dollar

Currencies / US Dollar Feb 07, 2010 - 04:23 AM GMT

By: Bryan_Rich


Best Financial Markets Analysis ArticleThe debt problems in Dubai threw a wrench in the happy-go-lucky risk trade of last year. And since then, the perception of the state of the global economy has been unraveling.

All of the sudden, the world isn’t as safe a place as was thought just months ago: Global stock markets are falling, commodity markets have cracked, and foreign currencies are back in decline.

All of this has been good for the U.S. dollar.

In fact, the dollar is operating in a win-win environment these days. Heads the dollar wins; tails practically every foreign currency loses.

Here’s why …

When evaluating the prospects for economic growth and recovery, the U.S. economy is expected to do better than other major economies around the world. And the Fed is winding down its extraordinary policy programs sooner than the likes of the UK and Japan. So, with respect to economic growth and interest rate prospects, global investors have had a growing bias toward buying dollars.

Furthermore, global risk appetite is taking a hit.

When that’s the case, investors become less concerned about where the best projected returns might be, especially given the rosy assumptions made about recovery in those projections.

Investors are seeking refuge in the world’s safest market.
Investors are seeking refuge in the world’s safest market.

Instead, they become more concerned about the ripple effects of a potential debt crisis, so they seek shelter. And the safest place to park capital is in the deepest most liquid capital markets and currency in the world: The United States and the U.S. dollar.

As I laid out in a December Money and Markets column, back when the masses were still predicting the imminent collapse of the dollar, there are four catalysts at work that are projecting another leg of safe-haven demand for dollars — and potential crisis for other currencies.

Here’s what I said on December 12 and how it’s playing out …

Catalyst #1 — Rising Prospects of a Sovereign Debt Crisis

I said …

“Debt problems in a global crisis have the ability to be contagious. And that can destroy investor confidence in the capital markets of such countries, and in the global economy. And when confidence wanes, capital flees. That’s a recipe for falling dominoes.”

How it’s playing out …

The dominoes are lining up. What started with Dubai, quickly turned the market focus toward Greece. Now the ratings agencies are warning of downgrades on Portugal, Spain, Italy, Ireland … and even France! And last week the outlook for Japan was downgraded. It’s fair to say then that a sovereign debt crisis is underway.

Catalyst #2 — Problems for the Euro

I said …

“So the uneven performance in Europe will likely call into question the viability of the euro currency again. Another bout of speculation of a break-up of the euro is hugely dollar positive.”

If a euro member exits, the common currency could be in trouble.
If a euro member exits, the common currency could be in trouble.

How it’s playing out …

The European Monetary Union’s credibility has been damaged. All of the sixteen countries in the monetary union have either breached or completely disregarded the Stability and Growth Pact by running excessive deficits. Greece and other gross offenders are exposing the EU’s inability to enforce fiscal deficit limits.

And the unknown implication of a failure, and/or exit, of a euro member country is increasing speculation of a break-up of the euro currency.

Catalyst #3 — Growing Uncertainty Surrounding Economic Recovery

I said …

“Moreover, when you answer a liquidity crisis with more liquidity, you’re bound to create more bubbles. While ground zero for the credit crisis was the U.S. housing market, new bubbles in real estate are developing in the areas that were relative outperformers in the downturn (such as China, India and Canada).”

How it’s playing out …

After Chinese banks drenched the country with new loans throughout the first half of 2009, the Chinese government stepped in and applied the brakes, fearing asset bubbles. That’s increased concern about a slowdown or worse, a crisis, in China. And that has resurfaced concern about a double-dip recession for global economies.

Catalyst #4 — Protectionism

I said …

“Perhaps the biggest factor in the protectionism threat is China’s currency policy … As this issue with China’s currency gains in intensity, expect protectionist acts to rise, in retaliation. And expect collateral economic and political damage.”

How it’s playing out …

Currency issues are causing friction between the U.S. and China.
Currency issues are causing friction between the U.S. and China.

As expected, China’s currency manipulation is a hot topic. President Obama recently made his most aggressive statement on China, calling China’s goods “artificially deflated in price.” And the White House chief economic advisor threatened that free trade may not apply when countries were trading with nations that were pursing mercantilist policies.

In general, hostility between the U.S. and China is rising. China has accused the U.S. of wrongful accusations and pressures over trade policy, over the Internet, and over U.S. arms sales to Taiwan.

As you can see, these hot spots for the global economy that I presented in December are growing in intensity. But that’s to be expected. After all, we have just emerged from a near global depression, and have witnessed unprecedented global policy responses.

The outcome can’t be measured with any degree of certainty. And that uncertainty should continue to drive the safe-haven demand for the dollar.



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