The Dollar Is the Next Financial Crisis

Daily Telegraph November 30, 2009

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Advertisement Website of the Telegraph Media Group with breaking news, sport, business, latest UK and world news. Content from the Daily Telegraph and Sunday Telegraph newspapers and video from Telegraph TV. Enhanced by Google Home News Sport Finance Lifestyle Comment Travel Culture Technology Fashion Jobs Dating Games Offers News by Sector Comment Personal Finance Markets Economics Your Business Blogs Finance Video Fund Game Recession Interest Rates House Prices Edmund Conway Roger Bootle Liam Halligan Oil Prices Home Finance Economics Benign neglect may turn the dollar from a safe haven to a dangerous place to be The US government is shouldering a vast $12 trillion debt pile – that's 12, followed by 12 zeros.

By Liam Halligan Published: 6:10PM GMT 28 Nov 2009

Comments 12 | Comment on this article

The trade deficit of the world's biggest economy also remains huge. How much longer can the dollar defy gravity?

Last week, America's currency fell to a 15-month low against the euro, cutting through $1.5050. Against a trade-weighted currency basket, the dollar was also at its weakest since July 2008. The greenback plunged to parity with the rock-solid Swiss franc, then hit a 14-year low against the yen.

The dollar's weakness is based on fundamentals – not least America's jaw-dropping debt. It's a long-term trend. From the start of 2002 until the middle of last year, the dollar lost 30pc on a trade-weighted basis.

It was during the summer and autumn of 2008, though, that the sub-prime debacle entered its most vicious phase (so far). The rescue of Fannie Mae and Freddie Mac, America's quasi-state mortgage-lenders, followed by the Lehman collapse, sent shock waves around the world. For six months or so, Western investors piled into what they knew, liquidating complex positions and buying plain dollars. The greenback became stronger, spiralling upward during the so-called "safe haven rally".

All that has now changed. The trade-weighted dollar has lost 22pc since March. One reason is that, since the spring, the Federal Reserve has been printing money like crazy – both to bail out Wall Street and service America's rapidly growing debt.

Sophisticated investors have also been exploiting America's ultra-low 0.25pc interest rate to borrow cheaply in dollars, switch these borrowings in currencies where returns are higher, then pocket the difference. This so-called "carry trade" has flooded foreign exchange markets with US currency.

The dollar fell particularly sharply last week, though, as traders were reminded of the patently obvious – that the White House actually wants the dollar to fall. US Treasury officials have lately taken to staring into the TV cameras, puffing out their chests, then stating: "We are committed to a strong dollar." That's nonsense, of course, because a weaker currency boosts US exports and lowers the value of America's external debt.

When the minutes of the Fed's latest policy meeting were published on Tuesday, describing the dollar's decline as "orderly", the markets rightly took that as confirmation of America's "benign neglect" approach – with intervention to support the dollar unlikely. The minutes also showed the Fed's key committee members voted "unanimously" to keep interest rates at rock-bottom for "an extended period" – another reason to sell.

In addition, the Federal Deposit Insurance Corporation, the fund that safeguards US bank deposits, warned that the number of "problem" banks grew in the third quarter, leading to speculation it could seek a credit line from the US Treasury. That would mean more borrowing and money-printing, concerns which sent the dollar even lower.

Yet "benign neglect" is fraught with danger. A weak US currency makes commodities more expensive (seeing as they're priced in dollars). It was when the dollar hit an all-time low of $1.60 against the euro during the summer of 2008 that oil soared to $147 a barrel. Expensive crude damages the economy of the world's biggest oil user. And as the dollar falls, America's huge commodity imports cost more, making the trade deficit even worse.

On top of all that, a falling dollar makes it even more difficult for the US government to meet its massive borrowing needs. Just to service existing debt,

By Liam Halligan Published: 6:10PM GMT 28 Nov 2009

Comments 12 | Comment on this article

The trade deficit of the world's biggest economy also remains huge. How much longer can the dollar defy gravity?

On top of all that, a falling dollar makes it even more difficult for the US government to meet its massive borrowing needs. Just to service existing debt, America must sell $205bn of Treasuries this year, a total set to hit more than $700bn a year by 2019 – even if annual budget deficits shrink. Selling long-term sovereign debt, in a currency expected to fall, is not easy.

Almost every American economist I know dismisses these concerns. Several have contacted me over the last 48 hours, gloating that the dollar has just put on a renewed "safe haven" spurt in the midst of fears about Dubai.

Yet the state of the dollar poses enormous dangers. For one thing, America's currency depreciation trick could backfire if "the rope slips" and a steadily dollar decline turns into free fall. The cost of US imports would soar, with the Fed being forced to sharply push up rates. The world's largest economy would then be caught in a stagflation trap – a slump, but with high inflation.

A more immediate concern is that a blind rush into the US currency could cause the carry-trade to go badly wrong – with those who've borrowed in dollars suddenly owing more, while their dollar-funded investments elsewhere are worth less.

A rapid "unwinding" could cause major losses at financial institutions, posing renewed systemic dangers. Far from being a safe haven, the dollar is the likely source of the next financial crisis.

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Comments: 12

Jon is correct in my view. When the carry trade in dollars unwinds the dollar should rally hard,last hurrah indeed.

The mentally of those responsible for the financial crisis has not changed. Those responsible were bailed out and see no reason to change their ways. These people are still in control of our economy so it is safe to assume that we will have to suffer further economic pain until the stupidity of bailing out the reckless is cleansed from the system. There is much more economic pain to come!

Good call. Jeremy Warner is also looking for Dubai to lead to Sovereign debt being in the spotlight. The only thing holding up the economy is excess liquidity inflating assets. That is fine until it sloshes around in a panic. Around $600 trillion of derivatives are still around, with more being printed. No-one can resist that tsunami if it shakes loose. Some argue that they cancel out with debits and credits unwinding. What about time intervals? If payments are delayed on 3% of this, then money in excess of the US economy is at risk. The present financial situation is totally unsustainable.

As ever a great piece Liam, sadly like yourself i see this all ending in tears for our unknowing society as we tend to follow where America leads! On friday just gone I went to London to purchase the only true global currency which will protect us from this on going madness of the printing press and all it's eventual effects, while travelling on the train I re-read chapters of Strauss & Howe's An American Prophecy, The Fourth Turning, a must read in what I believe WILL be our eventual outcome.

"A rapid "unwinding" could cause major losses at financial institutions, posing renewed systemic dangers" Don't worry, Liam. The taxpayers of the world will bail out the gamblers and cover their losses if it goes wrong. The gamblers, of course, will get to keep their gains if it pays off. Remember: Privatisation of gains. Nationalisation of losses.

On the mark again - Liam Halligan is not afraid to tell it as it is - unlike that Globalist Bootle.

Those "gloating economists" should look again. The DXY closed back on its arse at 74.87; gold pared its losses and closed a few bucks down on the day and the euro was back up close to $1.50. The dollar's safe-haven status is nothing of the sort and, should Black Friday retail sales figures or what-have-you prompt a sharp sell off in riskier assets, those who are betting on a repeat of the flight to safety trade that benefited the greenback in the months after Lehman had better think again because the dollar, the battery of US deficits and the expectations of additional stimulus in the months ahead make this a deeply flawed strategy for any period of time exceeding 3 weeks.

How does a weak dollar reduce the value of US external debt? If it's priced in foreign currency (which most isn't) then it increases it, if it is priced in dollars it remains the same. Inflation will reduce it, but it's not the same thing.

Healing will only come if and when the US admits it has a debt problem. Till now, only denial. The Keynesian economists (they who believe we can print our way out of the problems, like Krugman) will soon be morally bankrupt and replaced by Austrian economists who advocate "honest" money.

Liam says "Almost every American economist I know dismisses these concerns. Several have contacted me over the last 48 hours, gloating that the dollar has just put on a renewed "safe haven" spurt in the midst of fears about Dubai." He should get to know some Austrian economists. Hayek's teacher, Ludwig von Mises, wrote decades ago, "There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of the voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved." Read some of today's bright Austrian economists at www.mises.org

"Almost every American economist I know dismisses these concerns. Several have contacted me over the last 48 hours, gloating that the dollar has just put on a renewed "safe haven" spurt in the midst of fears about Dubai. " Liam doesn't know the right sort of economists. Ludwig von Mises wrote many decades ago, "There is no means of avoiding the final collapse of a boom brought about by credit expansion. The alternative is only whether the crisis should come sooner as a result of the voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved." Read what his present-day students are saying at www.mises.org

Good article. You seem to be correctly at odds with AEP over this one. Ron Paul, the US Congressman pointed out recently that the Federal Reserve recently issued $75bn of debt of which only $12bn was externally bought. The type of US debt being bought by foreigners is now predominently short term dated which shows that foreign buyers are very suspicious of the state of the US. Also a lot of longer term external debt is now being rolled over into short term debt. Look at China's US debt holdings. Here is the Ron Paul link:- http://www.dailypaul.com/node/115914 Whether people are able to understand it or not,or simply ignore the facts, the US debt problem is critical. The forecast GDP growth forecasts of the Obama admin are for pre crisis boom levels, ie over 4%, and this is just not going to happen. This will have a massive impact on US debt levels as a percentage of GDP, further undermining the Dollar in due course. It will lead to higher interest rates and much higher debt repayment levels. A very dangerous long term scenario.

Yes,the unwinding of the dollar carry trade would be a big deal, involving systemic risk. Stagflation is my bet. Probably deflation of many assets however in real terms. Roubini warns of the mother of all asset price crashes when fiscal tightening occurs. Interest rates in double figures?

The Dollar Is the Next Financial Crisis

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