Sunday, September 21, 2014

The Counter-Intuitive Rise of the U.S. Dollar

As things get dicier globally, assets in periphery nations typically get dumped as mobile capital flees risk and migrates to lower risk core nations and currencies.

I received many thoughtful comments on Why the Dollar May Remain Strong For Longer Than We Think. Given the many weaknesses of the U.S.--ballooning social-welfare and crony-capitalist liabilities, free money for financiers monetary policies, etc.--a strengthening dollar (USD) strikes many as counter-intuitive.

The dynamic complexities of fiscal and monetary policies, global capital flows and the foreign exchange (FX) market complicate any inquiry, so I try to keep it simple.

In my view, the USD serves both transactional (global trade) markets and the global need for currency reserves (i.e. as a store-of-value). Sorting out the various influences on its relative value in each capacity is complex enough, but there is also the X Factor--the hard-to-quantify components of any currency's relative value.

For the USD, the X Factor is hegemony, which includes financial dominance based on debt issued/denominated in USD and what might be called the real-world assets of the issuing nation: that nation's food, energy and water security (what I call the FEW resources), its proximity to potential enemies, its external environmental costs, its overseas financial assets, the strength of its legal system in protecting private assets,its demographic profile and of course its ability to project power to defend its interests.

By these basic measures, the U.S. scores pretty well. We can get some perspective on this by putting ourselves in the shoes of wealthy people in periphery nations where the risks of capital controls, currency devaluation, etc. are perceived to be high, or in the shoes of corrupt elites in countries where they fear their ill-gotten gains might not survive blowback (hence the almost universal desire of elites to leave China with their loot).

The strength of the USD is attractive to at-risk capital, even if transferring at-risk wealth into dollars requires a significant foreign-exchange haircut. Better to preserve 75% of your wealth in USD than leave it exposed to confiscation, capital control, etc. This is the basic flight-to-safety mechanism.

Ubiquity also counts. The USD is the proxy global currency. A $100 USD bill is recognized as money virtually everywhere. If you're stranded just about anywhere, USD will buy you food, transport, official "assistance" via bribes, etc. No other paper currency is even close to ubiquity/recognition. (Clean, crisp $100 USD bills are recommended--dirty crumpled bills are not highly esteemed.)

It's also critical to look at the relative scale of the money-printing that erodes the value of currencies: -China's credit expansion is much larger as a percentage of its economy and financial system than the Fed's money-printing as a percentage of the U.S. financial system.

Then there's the scramble-for-yield issue: imagine you're managing $10 billion. You need to preserve this wealth but you also need to earn a yield, or you'll be fired at the end of the quarter. Since FX (foreign exchange) is a much larger market than stocks or bonds, you're highly attuned to FX so you don't get blindsided by a shift in FX that wipes out your yield. You might wisely build an "insurance" position in precious metals, but because you need yield then you have exposure to bonds, stocks and as a result, FX.

As things get dicier globally, assets in periphery nations typically get dumped as mobile capital flees risk and migrates to lower risk core nations and currencies.

For money managers, the USD is an FX safe haven--especially since the capital flowing out of the riskier periphery pushes the USD higher. This makes for a secondary yield--as the USD rises, any asset denominated in USD will gain in relative value. So there's a self-reinforcing feedback loop: as the USD value rises, it attracts more of the money fleeing risk.

In a way, the USD acts as a currency equivalent of the English language. There are many languages and many currencies, but at present the indispensable language/currency in the global economy is English/USD.

How can we summarize this discussion?

1. FX is the "master market" of the global financial system.

2. The flow of mobile capital out of the periphery into the core will turn into a flood as global risks rise.

Both of these conditions favor the USD.

Get a Job, Build a Real Career and Defy a Bewildering Economy(Kindle, $9.95)(print, $20)
go to Kindle editionAre you like me? Ever since my first summer job decades ago, I've been chasing financial security. Not win-the-lottery, Bill Gates riches (although it would be nice!), but simply a feeling of financial control. I want my financial worries to if not disappear at least be manageable and comprehensible.

And like most of you, the way I've moved toward my goal has always hinged not just on having a job but a career.
You don't have to be a financial blogger to know that "having a job" and "having a career" do not mean the same thing today as they did when I first started swinging a hammer for a paycheck.

Even the basic concept "getting a job" has changed so radically that jobs--getting and keeping them, and the perceived lack of them--is the number one financial topic among friends, family and for that matter, complete strangers.

So I sat down and wrote this book: Get a Job, Build a Real Career and Defy a Bewildering Economy.

It details everything I've verified about employment and the economy, and lays out an action plan to get you employed.

I am proud of this book. It is the culmination of both my practical work experiences and my financial analysis, and it is a useful, practical, and clarifying read.

Test drive the first section and see for yourself.     Kindle, $9.95     print, $20

"I want to thank you for creating your book Get a Job, Build a Real Career and Defy a Bewildering Economy. It is rare to find a person with a mind like yours, who can take a holistic systems view of things without being captured by specific perspectives or agendas. Your contribution to humanity is much appreciated."
Laura Y.

Gordon Long and I discuss The New Nature of Work: Jobs, Occupations & Careers(25 minutes, YouTube) 

NOTE: Contributions/subscriptions are acknowledged in the order received. Your name and email remain confidential and will not be given to any other individual, company or agency.

Thank you, John S.P. ($50), for yet another extraordinarily generous contribution to this site-- I am greatly honored by your steadfast support and readership.

Terms of Service

All content on this blog is provided by Trewe LLC for informational purposes only. The owner of this blog makes no representations as to the accuracy or completeness of any information on this site or found by following any link on this site. The owner will not be liable for any errors or omissions in this information nor for the availability of this information. The owner will not be liable for any losses, injuries, or damages from the display or use of this information. These terms and conditions of use are subject to change at anytime and without notice.

Our Privacy Policy:
Correspondents' email is strictly confidential. The third-party advertising placed by Adsense, Investing Channel and/or other ad networks may collect information for ad targeting. Links for commercial sites are paid advertisements. Blog links on the site are posted at my discretion.

Our Commission Policy:
Though I earn a small commission on books and gift certificates purchased via links on my site, I receive no fees or compensation for any other non-advertising links or content posted on my site.

  © Blogger templates Newspaper III by 2008

Back to TOP