Martin Wolf writes an interesting column in the FT.com October 13, 2009:
It is the season of dollar panic. These panic-mongers are varied: gold bugs, fiscal hawks and many others agree that the dollar, the dominant currency since the first world war, is on its death bed. Hyperinflationary collapse is in store. Does this make sense? No. All the same, the dollar-based global monetary system is defective. It would be good to start building alternative arrangements.
We should start with what is not happening. In the recent panic, the children ran to their mother even though her mistakes did so much to cause the crisis. The dollar's value rose. As confidence has returned, this has reversed. The dollar jumped 20 per cent between July 2008 and March of this year. Since then it has lost much of its gains. Thus, the dollar's fall is a symptom of success, not of failure.
This is an idea that we have covered at some length during the course of the year, so it is a dear subject for us to feature, as it goes hand in hand with the raging debate between equity bull and bear, and deflationist vs. reflationist.
During the first quarter of this year, when equity markets were tanking the dollar was strengthening, and that was a direct result of the market taking a large long position in the dollar, via cash instruments and other short term government securities. By February 2009, the Fed's cash position had reached such an untenable shortage because investors and banks were hoarding it, that the Fed and Treasury Department were forced to resort to Quantitative Easing (QE) measures that added $2-trillion of printed liquidity into the credit market. Most in the market missed the fact that there was, at the time, a panic among monetary authorities that the physical supply of cash would run out.
With the Dow benchmark crossing over 10,000 yesterday, and other markets attaining commensurate or higher levels, is it any surprise, given that US$450-billion has moved from money market funds alone to be re-invested, that the dollar is faltering? In the simplest of terms, the global equity markets' slingshot recovery has led to a slingshot devaluation of the dollar.
Superficially, the shortage of cash in February was deflationary. In the present, the flood of liquidity from QE, plus the US/UK Zero-Interest-Rate-Policy, are fueling re-investment in risk assets, and driving the dollar to an out-of-balance devalued state. To put it mildly, if this is the current basis for long term inflation, it too, is rather shallow.
The most likely scenario at this stage would be monetary intervention - and that means that while gold may continue to rise a little bit further from its current highs, it is due for an IMF selloff in concert with the G20, all of whom have a vested interest in seeing the greenback at higher levels against the Euro, Yen, and RMB.
The less likely scenario rests with whether or not the Fed can convince its public that the economy is expansionary, thus enabling them to reinstate an interest rate, which too, would raise the dollar's value and repatriate cash from assets to the money market.
Our suspicion is that the Canadian dollar's recent run and that of other non-dollar centric currencies would end upon either scenario.
Therefore, there may be a strategic currency-based opportunity in buying US dollar denominated assets, and preferably in short term government securities. If you have the stomach for it, the real opportunity may be in longer dated US government bonds, as either intervention or re-instatement of interest rates would result in lower long term yields.
