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10/22/08

Why the dollar is strong (and gold, silver etc etc are weak)

I just received another one of those "It's mystifying how gold and silver have sold off" mails this afternoon. So let's put some broadstroke ideas out on the blog (even though this isn't really LatAm material). It's really pretty simple. It's not about gold, silver or any other commodity, it's about the US Dollar. In simple bullet-point form:

1) Under normal circumstances, any country faced with recession needs its currency to devalue relative to others to make its country, products, goods, services etc competitive in the world market, therefore grow out of recession. It's the typical cycle....no brain surgery needed.

2) When its currency drops, it also puts up a de-facto imports restriction (i.e. locally produced goods and services become more attractive than more expensive items imported from overseas). As an example of the flip-side, Venezuela is the classic overvalued currency at the moment and its internal industry suffers as a consequence.

3) However the country in question this time is the USA. Firstly it is a net importer on a vast scale. Secondly its exports tends to be cutting edge sectors in tech, biotech, pharma and finance that hold their competitive edge at whatever dollar ticket price.

4) Therefore it is perhaps...repeat perhaps...unnecessary for the dollar to go through its weak phase to bring the country out of recession.

5) Meanwhile, the USA is the implicit "world leader" and does not want to lose that position. If its currency weakened sufficiently it would mean that:
  • net exporting countries would look for new markets more vigorously
  • commodities prices would revalue in dollar terms and bring more wealth to the net exporters and imply less wealth for the net importers (eg W Europe, Japan, USA)
Or put simply: If the current "leaders of the world" (for want of a better phrase) make a concerted effort to keep the dollar strong, they will not lose their place as the most important nation(s) on earth.

As a by-product, the economies of the traditional net exporting nations (for example Peru) and the commodities in which they deal (for example silver) are suppressed.

Conclusion: It seems to me that the USA has two ways of going through its recession. It can either take the logical/natural (in economics terms at least) road and pass through its recessive phase with a weakened currency. Or it can pass through recession with a strong currency. With a weak currency the rest of the world is less affected but the after effect is a less influential USA on the world stage. With a strong currency the USA drags the rest of the world into its recession, but the after effect is that it remains the top dog as people will continue to want to sell plastic dolls and things to its market and will be actively hoping that the USA improves as quickly as possible (so that its most profitable market is quickly restored).

Therefore, the USA is doing everything in its power to maintain a strong dollar, because it doesn't care so much about the whole world suffering as long as it remains the world's most important once the recession is finished. It will probably be encouraged in this effort by the other main industrialized countries that will also benefit from status quo. I repeat; the USA is and will continue to base its whole plan around one thing; "keep the dollar as strong as possible". It is the number one basic element of all its crisis planning.


UPDATE: I'm writing an update on this post at 7:41am this next morning because I'm already fed up about having to multi-answer the same counter-argument via mail. Yes, there's all that carry-trade thing, isn't there? But if you think that explains things then you also say that once the carry trade phenomenon is done there will be an equal and opposite downside to the dollar. Ok, that may happen, but it ain't necessarily so, either. What I'm proposing here is the carry trade explanation puts the cart before the horse. It's not the cause, but the effect. It's how it's happening, but not why.

When the dollar returns to USD72, write me and tell me how wrong I was. Until then, don't you think that all experts saying exactly the same thing at exactly the same time is a little suspicious, especially given those same experts' recent track record in understanding world finances?

UPDATE 2: This is most definitely the final update on this issue. Instead of getting on with my job the e-mail exchanges have continued for the last two hours with several people. I can distill my position in those mail exchanges into the following:

I just don't buy all the "it's carry trade" chorus. It fits, yes. But it's also the new chorus coming from a bunch of people who have been scrambling behind the curve for weeks, months or even years; why should I or anyone else blindly accept they should suddenly be ahead of the curve with this explanation? The carry trade explanation is choosing yet another after-the-fact scenario that fits. What I'm proposing is an a priori scenario that also fits the evidence we see around us.

I repeat the basics here;

The USA will benefit from a strong dollar policy going fwd.

If the dollar drops to sub 78USD (or so) then I'm wrong, it was pure carry trade and there is nobody at the helm of this dollar move.

Whether by accident or design, the current dollar strength will keep the USA and the industrialized nations in the box seat and will suppress the net exporting nations' economies.

I'm now going to crawl back under my stone and stick to all things LatAm, as mentioning to N. American readers that they might be wrong about their own financial analyses (after all the recent evidence too!) seems to rile too much from an outsider. I never mind about being proved wrong on these kind of things, but I'm always surprised about how religious other people get in defending hastily put together theories and daren't even think about any other logical alternatives.