Coming dollar crash?

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A friend sent me this analysis. If he is right, and his argument looks sound, which currencies should we consider moving to if/when the dollar starts to crash?

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That's the main reason I'm following all of this crap. I want to know what the dollar will do.

The dollar has been in slide for years - down 40%, even though it's the reserve currency, which shows you how bad the US's finances are. You gotta be pretty lame to have your reserve currency get trashed on teh world markets.

But it's come back almost 20% in the last few months. There are three reasons for this, as best I can gather, and all three are time-limited, which means that it looks like the dollar will continue to rise as they continue to happen, and as soon as they stop, it will plummet:

1 - The world is in a massive process of deleveraging, which means that banks, hedge funds, private equity groups, investment banks, etc etc, have for years been buying assets, borrowing heavily against them, buying more assets, borrowing heavily against the new assets, etc etc, until places like Lehman Brothers, Bear Stearns, et al, were so leveraged that they owned 30 times more assets than they started with - all with borrowed funds. As assets began to fall (stocks, real estate, commodities) essentially what has happened is the largest margin call in history. As their assets fell in value, their lenders had the right to ask them to put up more money - so they all, simultaneously, had to start selling assets - which drove the prices down further, which triggered more margin calls, which drove prices down further, triggering more margin calls, and on and on. Everyone needed dollars to meet their margin calls, so the demand for dollars skyrocketed, so

naturally the value of the dollar went up.

2 - Flight to quality. Yes, most every other major economy looks as bad as the US. The UK and the EU actually look worse. US banks have stronger caps on how much they can leverage, and larger reserve requirements, than the UK and EU banks. This is why the US stopped the bleeding with a mere $250 billion, while the UK had to immediately put up $500 billion to stop their banks from all collapsing. The UK is much much smaller than the US. In times of panic, the US has the ultimate backing for its currency - it's the largest military power on earth. Scared money runs to the US. People everywhere are selling their foreign holdings and converting the proceeds to dollars, and buying short-term treasuries. It's the fetal position. Demand for dollars - the dollar rises

3 - The carry trade. I'm a rookie, so this one is new to me, but fascinating. For years, major players have used a strategy of borrowing money from banks in countries with very low interest rates, and then buying government bonds in other countries paying higher interest rates. When Greenspan had rates at 1%, people borrowed all they could, and bought, say, Eurobonds yielding 5%. This is free money - if exchange rates are stable. They even made a windfall as the Euro rose (part of the Euro rise WAS the carry trade - people borrow dollars, exchange them for Euros (driving up the Euro), and buy Eurobonds with their new Euros. Party time. The carry trade was even larger out of Japan, home of the 0% interest rate. Everyone who could was borrowing Yen to buy, say, Australian bonds at 6%. Free money. Unless....oops, the exchange rate is reversing. In the last few months, the Euro has lost 20% against the dollar, and 35% against the Yen. That 5%

annual gain looks pretty stupid when you lose 35% of your principal in 3 months. The stampede for the exits is on. Everyone is unwinding their carry trades at once, selling Eurobonds, trading their Euros for dollars (driving the dollar up more, making more carry-traders freak out) and paying off their dollar loans. Or their Yen loans. It's like watching a herd of sheep, first running in one direction, and then all reversing course and running back the other way. In the history of markets, 'twas ever thus.

All three of these forces are driving up the dollar and the yen. And they will continue to for as long as they continue to play out. But as soon as they stop, well the yen will be okay - the Japanese have a huge trade surplus, so yen will stay in demand. But the US has a huge trade deficit. The only thing we export are bad attitudes. When this song stops, the dollar will look like Wiley Coyote in the Road Runner cartoons, right after he's just run off a cliff and there is that moment when he hangs in midair, realizing what happened, adn then....zip.

It's all a matter of timing. Unfortunately, like most market trends, we won't know it happened until after it has happened. There are no statistics that will show when the deleveraging has run its course, or when the carry traders have closed their positions, or when panic and flight to quality has stopped. My only sense of how to gauge it is to watch for a trend reversal in the dollars rise. My suspicion is that it will bounce around a bit, but at some point, it will resume its long term trend downward that it's been in for years because of our massive deficits. When I see this trend start to gain some momentum, unless I see some new factors at play, I have to assume that it will be a strong trend down, for quite a while, and that's how I'll play it. At a minimum,I'll hedge into other currencies, or gold. If I feel like gambling,I'll get out of the dollar altogether. Easy to do. Takes 10 minutes.

And add to this, if the dollar ever begins to lose its reserve currency status, there are trillions of them sitting in foreign central banks, where they are needed so the locals can exchange Euros, Yen, Yuan, Pounds, etc etc to buy oil and other things - and most of those will no longer be needed to be held, so they'll all come back here to be exchanged - and that will really drive the value down. Hasn't happened yet - 67% of the world's currency in central banks is dollars, but the Euro has been rising steadily for 10 years and is up to about 25%. Any international consensus that says, "Fuck the dollar. We need a new financial architecture where we all just trade with our own currencies", as the Chinese are suggesting, as well as others, and the US will start to look like one of those Emerging countries that got bailed out by the IMF when their currency dove - bailed out with really harsh conditions attached - like, no more deficits, cut social

spending to the bone, no more trade deficits.... It would be a real circus to watch the fat US try to adapt to THAT. 8-)

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andrew

 

Maybe not next Saturday after the meeting, maybe not next month, maybe not next year, but it will happen, I mean, it is in the process.

Look at the Pacific currencies, though right now European currencies are helping my pocket a lot.

 

I think we are living the dollar crisis, is not enough the banks in crisis and the dollar coming down in the market?

 

Isn’t that correlated? I think if Oz banks are in crisis for example then the currency is going to be affected and it probable that it goes down. If I’m wrong please correct m

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