Thursday, January 22, 2009

Dollar Downfall

Right in the middle of this crisis, when Lehman and other US institutions were imploding on a daily basis, I think it was actually pretty rational to worry that after everybody piled into Treasuries in the flight-to-safety trade, they would all shortly come piling back out in a paper-money-is-bunk trade.  If "trade" is what you would call that.  Ergo gold.  This was right but wrong.  Gold surged quite a bit during the crisis, but fell back immediately as it became clearer and clearer that people weren't going to stop believing in paper money, and particularly not in the dollar, just yet.  Part of this was related to the fact that it was quickly apparent that the problems were not confined to the US, and that basically most of the G7 banking system (save Japan) was going to end up as a ward of the state.  In that case, the dollar is unlikely to be any worse than the euro or the pound.  So your only choices as an alternate store of value were the yen and gold, and, well, the yen won.


I don't know whether gold will eventually close this gap (after all, what the hell is the difference between the yen the dollar and gold?  None of them pay an interest anymore, two of them can be produced indefinitely at the drop of a government bureaucrat's hat, both of these governments are deeply in debt, one of them to a bunch of chinamen, (that is, to guys who don't vote in their own country) and both have deeply and fundamentally broken political systems).  But I am less worried now about the immediate collapse of the dollar, given that holders of our debt are not in panic mode, perhaps simply because they have no better place to go to store their value, given the size of the value they need to store.  Why panic if you know in advance there's no chance of getting to the exit?

Ths does not however mean that the dollar is on solid ground in the more distant future.  The US still has too many major imbalances to make it a satisfying reserve currency, and we should expect the current legacy effect to gradually wear off.  This is all prelude to a much more detailed analysis that Brad Sester published today, tackling the question of exactly how the US has financed its current account deficit since the criss started (short answer - short term borrowings).  I found the final elipsis interesting and ominous, if not wildly helpful in telling me wht to do with my money:

At the same time, it is risky to finance a large external deficit with short-term debt. Even for the US. If the US deficit starts to head back up again — as, for example, the effect of the recent fall in oil prices wears off and a large fiscal stimulus in the US stimulates the world economy — without a shift in the composition of inflows, there would be cause for concern.

That just highlights a bigger issue, one that I don't think has been settled: How will the world's remaining current account deficits be financed in the post-crisis world? Right now, they are in some sense being financed by the unwinding of all the pre-crisis bets. And by running down existing stocks of foreign assets. But that process cannot last forever …

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