Hi Reid,
Whatever one might think of the potential consequences of the sinking dollar/expanding trade deficit, I thought this was an interesting take on the mindset of traders in the largest market in the world (the Forex).
As an aside, there was one day in September when the Treasury auction failed to attract the usual crowd of buyers from Japan and China, causing something of a panic, since the US is very dependent upon foreign investors to finance our expanding debt. As the yield on treasuries drops, the investment becomes worth less, and this is only exacerbated by a falling dollar against the yen (and the Euro, for that matter). And of course lack of buyers means the yields must increase according to the law of supply and demand, but this makes financing the debt more expensive. As it turned out, the next auction brought the usual interest from buyers. Still, it was a rattling experience for bond traders. Not sure what the eventual significance might be, but it did underscore how interdependent we are upon other economies. Also, treasury yields have stayed persistently low despite the rise in the central rate. I view this as untenable in the long run. Eventually the rates must rise as demand changes. And, as that occurs, the debt becomes more expensive to service.
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Is the dollar doomed?
By Mark Hulbert, CBS.MarketWatch.com
ANNANDALE, Va. (CBS.MW) -- For some time now I have been skeptical of the case for the dollar's continued decline.
It's not that I take issue with the individual arguments that make up that bearish case -- arguments based on the United States' burgeoning trade gap, federal government deficit, and so forth.
On the contrary, those arguments seem eminently sensible.
If anything, in fact, my skepticism derives from those arguments being too obvious. I can't imagine that there's any active investor or trader left in the world today who isn't very aware of those arguments and their bearish implications for the greenback.
And therein lies the problem for the bearish case: Why, if the bearish arguments are already widely recognized and accepted, hasn't the dollar's value already declined far enough to reflect those arguments? What's left to force the dollar even lower?
My questions aren't motivated by a belief that the markets are always right. Investors collectively sometimes make huge valuation errors, as witnessed by the Internet bubble of the late 1990s.
Flawed as they are, however, the markets remain a stiff competitor. It makes me nervous whenever we blithely assume that we're right and the market is wrong.
Such an attitude seems especially worrying in the case of the foreign exchange markets, which are some of the largest and most liquid in the world. The amount of money that every day changes hands on those markets dwarfs the trading volume of the U.S. stock market, for example. Furthermore, foreign exchange traders are among the smartest in the investment arena.
To argue that the dollar must continue declining, after having already declined by a huge amount in recent months, aren't we in effect assuming we know more than they do, or are smarter than them?
I posed these questions yesterday to Dan Seiver, an economics professor at Miami University of Ohio, who also edits an investment newsletter called the PAD System Report. The most recent issue of his newsletter, which I received over the weekend, was devoted to an analysis of the dollar's prospects. In that issue, Seiver argued that a run on the dollar is virtually inevitable, sooner or later.
Why, I asked Seiver, hasn't the foreign exchange market already discounted the realities of his arguments?
One reason: Much of the smart money in the foreign exchange market, as well as many of the biggest players, focus only on the short-term: "For these guys the long-run is overnight!"
This predominant short-term focus means that the market does not do as good as job as it otherwise might of assessing the long-term implications of various geopolitical and macro-economic factors. This inefficiency creates profit opportunities for the rest of us.
Another factor that Seiver mentioned has to do with the role that arbitrageurs play in the foreign exchange markets. In theory, of course, they act as a counterbalance to "naïve" investors -- buying when those naïve investors are irrationally selling, and vice versa.
In practice, however, Seiver reminds us, arbitrageurs are often found taking the same side of trades as naïve investors. Far from acting as a counterbalance, arbitrageurs add fuel to the fire. One consequence is that foreign exchange markets frequently swing even further than they otherwise would between polarities of significant under- and overvalue.
If arbitrageurs in practice played the role that theory expected them to, then Seiver might have more confidence that the markets would resolve worldwide account imbalances with a minimum of disruption -- a veritable soft landing, in other words.
But because arbitrageurs don't play this role, a huge run on the dollar is a distinct possibility -- pushing the dollar not only down to fair value vis a vis the rest of the world's currencies, but even much further still.
Seiver concedes that he might be wrong. And he admits that he has cried "wolf" before, and at least so far he appears to have overreacted.
But he reminds us: "If you remember the fable, the third time the little boy cried 'wolf!' the big bad wolf was really there, the townspeople ignored the little fellow, and the wolf ate all the sheep. So, once again, we are crying 'wolf!, while most of the sheep sleep." |
