Thursday, April 27, 2006

FINAL DAYS OF THE US DOLLAR?

Excellent analysis by Chris Laird on the inherent instability of our current trade deficit... worth the read, but very worrying. The contention that the dollar may collapse soon is nothing new. However, the notion that the speed at which such a collapse could occur is terrifying...
The way it would happen would be that, many holders of large USD positions would be facing each other, waiting to see who pulls the trigger on the USD. Then all would fire at once, blasting each other with their USD asset sales, trying to salvage what remained of the real value of their US treasuries, US stocks, US bonds.

I surmised that, with the super fast electronic markets we have now, that, the USD could collapse in a matter of hours, not days or weeks. The idea that circuit breakers would stop this baby would probably fail because either the markets would just overrun them, or ‘bum rush’ them, or, there would be a week of limit down days, followed by another week of limit down days. End result? Possibly a complete or almost complete USD crash.

[...]

In short, since the USD is the economic common link to world commerce, product pricing, commodities pricing, factory price targeting, for everyone on the planet. If that link breaks, the entire world economy will experience massive market sell offs, plant closures, riots, shortages, job losses, real estate collapses. Not only the US would experience a financial catastrophe, the rest of the world would inevitably be drawn in.

Now, all of our trading partners know all this. This is one major reason the USD has held up all these years with the US running $800 billion trade deficits, $400 billion fiscal deficits, and even with the US consumer also going way into debt with over price homes, credit cards, and so on.

So, our trading partners have two alternatives. They can either initiate the flight out of the USD by selling a large portion of their USD assets such as US treasuries, or, they can hope for an orderly decline of the USD, and just take the net write down of their USD assets. SO far, they have been willing to take the latter alternative.

However, our trade partners are not a homogenous group either politically, economically, socially, or economically development wise. In fact, the only common thread of all of them is trade with the US / US consumer. This brings up a sticky situation. At some point, one or more of these large trade partners will decide that their part in underwriting the present system will come to an end. Their action could result in all the others jumping into the mess to save what they can and sell more USD assets before the USD crashed into oblivion.

Our trade partners’ purchases of US dollar assets like treasury bonds are not merely to support the US consumer, or the US economy per se. They are more concerned about a much bigger issue, the whole USD SYSTEM of commerce world wide.

[...]

The third alternative is of market crashes on their own. Financial panics on their own. Derivatives collapses on their own. With all the interrelated tentacles of these, the USD just might go ahead and collapse anyway, under the following scenario:

First, market crashes. Real estate collapses, derivatives collapses, bond collapses. All due to their own complexities and over priced conditions. The present synchronized state of all these markets being at peaks together will only make this more likely. (see my article Massive World Speculation Dominoes) Also the present synchronization would also mean that when they let go, the outcome would be so bad that we would imagine ourselves in the economic end of the world. Something like the Great Depression of the 1930s that enveloped the world in ten years of massive deflation.


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