Assaying the Fate of the Gravity Defying Dollar

♠ Posted by Emmanuel in at 3/01/2010 12:01:00 AM
As a standard-issue dollar bear, I am once again on the defensive as the greenback is gaining against the euro largely by default. That is, it is not the common currency at a time when Greece's fortunes are very much up in the air and knock-on effects lurk for other marginal Eurozone economies. Nevertheless, I ultimately believe that while Europe's fiscal health going forward measured in terms of national debt as a percentage of GDP are nearly as dreadful as America's, the former will eventually come out ahead for a number of reasons. First, there's the sheer size of America's forthcoming debt bonanza. Brother, can you spare me, say, $99 trillion? Second, there's the evident lack of a disciplining force in America. While the EU eventually cracked down on Greece, there's no such counterpart telling the US to shape up.

In any event, I do suggest you read Reuters' account of when the dollar will (somewhat inevitably) come back to Earth. What follows are the ending excerpts, though the rest is indeed well-worth reading:
Recently, the White House even pledged to double U.S. exports in five years, a goal that economists say would require a significantly weaker dollar. It's not clear how much other nations, particularly China, will go along.

In the post-Cold War era, currency talks are the rough equivalent of nuclear arms reduction negotiations. In language evocative of the U.S.-Soviet face-off, Chinese military officers have proposed punishing Washington with "a strategic package of counter-punches" that includes dumping U.S. government bonds. While the military plays no role in setting China's foreign exchange holdings, the comments underscored the rising level of tension and mistrust between the two powers.

Nicholas Lardy, a senior Peterson Institute fellow, dismisses such threats, noting that China's vast dollar wealth would start to evaporate and its currency to rise if it started unloading Treasuries. "The Chinese are in the classic dollar trap. They have so many dollars that they can't diversify," he said.

Marc Leland, head of Leland & Associates and deputy undersecretary of the Treasury during the first Reagan administration, said: "It's only leverage if one thinks they can pull the trigger. I don't think they can."

Morgan Stanley Asia chairman Stephen Roach isn't so sure. He said that if the U.S. eventually resorts to trade sanctions against China -- not unthinkable in a U.S. election year, with the unemployment rate near 10 percent -- Beijing would likely retaliate.

China might boycott a Treasury auction, he said, which could cause the dollar to plummet and interest rates to spike. "I spend a lot of my time talking to the Chinese about that, and if it happened, I think they would feel compelled to stand up and take strong retaliatory actions, even though, yes, there would be consequences for them as holders of Treasuries and other dollar-denominated assets," Roach said.

Merk, the investor who is betting against the U.S. currency, said the dollar's future may depend on Washington assuming a more humble attitude. "Once you believe that you are better and greater than everyone else, you have a problem," he said, "because today, the competition is right around the corner." That may be especially true for any winner of a reverse beauty contest.