Tuesday, September 09, 2008

The Truth Behind The Dollar Rally

Very interesting article that I recommend about how the latest dollar rally came into existence despite terrible dollar fundamentals. Regular readers of this blog already know about the main points in the article, as I have already alerted you to the massive increase in foreign central bank purchases of U.S. Treasuries and the market mechanisms created by the existence of "stop-loss" rules among investors, but it is still worth reading as it contains more detailed facts about these things than my posts.


Blogger Danny said...

You ignore all the facts supporting a dollar rally, and thus chalk it up to foreign central banks, who have been buying massive amounts of treasuries for years. A slight uptick in their buying does not constitute a reason for the huge rally the dollar has had recently.

It is pretty simple and people have gotten this right. The US is in the midst of a deflationary crisis. It's trade deficit is collapsing, and thus a huge source of worldwide dollar liquidity is evaporating (compare a chart of foreign reserve dollar holdings to the dollar index). The savings rate is increasing, and there will be more domestic demand for US treasuries. Yields are in the process of collapsing, even after the FNM/FRE bailout. There is huge demand for CASH now, because people will try to pay down debts before they default on them.

The dollar is going to continue to strengthen as deflationary forces pick up. The government can increase deficits all it wants, it will not help, look at the 30's for proof.

That is not to say the dollar will not collapse, it most certainly will. Just not yet, it will rally for longer than most expect and will not crash until most people believe it won't.

11:56 PM  
Blogger stefankarlsson said...

Danny, first of all, it isn't true that the U.S. trade deficit has been collapsing. It has been fairly stable and even increased (although only slightly). And while money supply growth has slowed dramatically in recent months, it is not shrinking.

And secondly, the increase in foreign central bank purchases has been anything but slight, we're talking about more than doubling it from covering half the U.S. trade deficit to covering more than 100% of it. Combined with the market mechanisms created by the existence of "stop-loss" and momentum trading, this is what accounts for the dollar rally.

That however doesn't necessarily mean that the rally will end very soon as the central bank buying could continue for a while.

4:20 PM  
Anonymous Asha said...

Hi Stefan,

The pound has been sliding..! But why is it that the swedish SEK seems to be sliding even more wrt asian currencies as well as (to a lesser extent) the pound? HAs it got to do with lending to eastern europe?

9:39 AM  
Blogger stefankarlsson said...

Asha, worries over this could have contributed to the weak SEK, but the weak SEK is not something new so there are other reasons for this.

4:07 PM  

Post a Comment

<< Home