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U.S. Dollar, USD Index Rally?

Currencies / US Dollar Nov 18, 2010 - 02:28 PM GMT

By: Christopher_Laird


Why the USD is rallying
Well why can the USD rally now with another $600 billion of US QE? Basically it is argued by some, including me, that since the US has the defacto world reserve currency, that even if the US wants to abuse it and print a lot of money, since they print it, and issue the USD, they can win any argument on currency rates.

That leaves the others, everyone including the Chinese, scrambling to adjust to the USD, not the other way around. OK then, when each of these countries tries to stop their currency rising against the USD, they find it only works for a week, and just complicates everything.

The trouble with that inability to regulate exchange rates is that the next step is for export nations to get panicky and start trade restrictions. China, the US, the EU and Brazil, everyone is getting an itchy trigger finger to fire up some trade restrictions.

Old nice days are over
But what the events at the G20 clearly showed was that the days of nice international trade are over. Now, things like currency wars (where each country makes its currency cheaper to encourage exports and get a larger share of a diminishing economic pie) and trade sanctions are being talked about quite a bit.

Even Germany, who is not using bank stimulus like the US, is criticizing the US’ easy money policy. Germany has been able to weather the economic storm better than most, as well as dealing with a stronger Euro. SO Germany and China both are loudly protesting US QE.

But, then how can the USD strengthen here at this juncture, if the US Fed is clearly committed to inflation?

Well, I think that many people will agree there is a very quickly shrinking pie for total world export sales. If the world consumer market is shrinking, then what is China going to do with all those new factories for example? If the world economy was built based on exports, and now that whole market is shrinking mainly due to the retiring baby boomers around the world, then the world economy will have to readjust to another model not mostly based on exports.

US T bond markets holding up
That will be a painful process. But as to the USD, since the US T bond markets are considered a haven that is cash like, and since world markets and economies must readjust to a post-consumer driven model, money will start to move into cash and out of the markets that focused on export driven economies. That can spell disaster.

Now, despite that immense US bond issuance, the USD is rallying. That is due to many things, and let’s not leave out the concern on the Euro. Ireland is the latest scare, but next is Spain, then others. All their bond spreads are rising. Markets are punishing the Euro as a result, and the USD benefits.

So, as long as the US bond markets hold up (the US T Bonds) and there is more demand for US bonds than needed, the USD can rally because it’s the main world currency that still has ultra liquidity. With the Euro’s bond problems, you aren’t going to tell me that the Euro is as good as the USD right now!

So, the USD ends up being the final place money ends up if there is fear in markets.

Hot money
Now, what would happen if fear entered all those ‘emerging’ markets, and more money fled to the USD??? If it was big enough, it just might be another financial panic like the 97/98 Asian crisis where the Yen rallied over 20% and Asian markets collapsed. Only this would not only be Asian markets. It would be all markets.

Clearly, if US financial markets were not rallying at the same time, then that hot money would start to flood into USD reserves here, and in companies accounts. We know US businesses are hoarding a great deal of cash now. That is the reason.

Now, what if all that hot money starts to flood out of emerging markets, even possibly out of China? It can rally the target currency by 20% as has been demonstrated already in the 97/98 Asian panic where the Yen rallied a staggering 20 plus percent in a few months and darn near collapsed the entire Asian financial world! In this case the target currency would be the USD.

Is this beginning in November 2010? The beginning of another huge USD rally? That is very possible.

Why did this happen now? Primarily because it became clear the G20 meeting was a total failure. All that meeting did was reveal the intense acrimony between the major players. So, the USD began its ascent. We are roughly two weeks into that.

Now, if US financial markets don’t rally this year, we may just see the USD rally into the 90’s on the USDX!

If, on the other hand, it appears US QE can reignite a US and world stock rally, then the USD will remain likely near its present range of around 78/79 on the USDX but with a bullish trend.

If US markets can rally into Christmas, gold and silver can continue a rally, but not if US financial markets sell down. I would also like to point out that several times in recent weeks the USD and gold rallied together. That is flight to safety. And that would fit the premise of our article here today.

By Christopher Laird

Copyright © 2010 Christopher Laird

Chris Laird has been an Oracle systems engineer, database administrator, and math teacher. He has a BS in mathematics from UCLA and is a certified Oracle database administrator. He has been an avid follower of financial news since childhood. His father is Jere Laird, former business editor of KNX news AM 1070, Los Angeles (ret). He has grown up immersed in financial news. His Grandmother was Alice Widener, publisher of USA magazine in the 60's to 80's, a newsletter that covered many of the topics you find today at the preeminent gold sites. Chris is the publisher of the Prudent Squirrel newsletter, an economic and gold commentary.

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