Someone else has finally noticed that a sea change has transpired in forex markets during the oil crisis. As this blogger noted last week, the $US has not enjoyed its traditional safe haven role on the flight to safety trade. Sovereign Man picks up the theme today to argue that this is the end for the greenback:
In the past, major crises normally caused investors to seek safe haven assets, and everything else equal, the dollar would rise. They call it a ‘flight to safety’, and investors would flock towards the perceived stability of US Treasury securities.
In 2008, for example, the Lehman collapse spurred the market to go rushing into the dollar. The pound, euro, S&P, oil, and gold all went into freefall, and the dollar surged. Anyone holding cash felt pretty smart, and the market paid tribute to the US dollar as the world’s safe haven currency.
There were a lot of reasons for why this happened. The US government likes to claim that it has never failed to pay on its debts. Of course, even the most cursory analysis would lead one to conclude that they trade debt for inflation… and more debt.
Regardless, when financial markets were collapsing in 2008, investors made a rational decision to accept negative real rates in the dollar (effectively paying a fee to hold short-term treasuries) over other currencies and asset classes.
It was the lesser of all evils at that particular moment and should not be conflated with ‘confidence’.
The other big reason for the dollar’s 2008 surge was that many of the world’s financial markets were leveraged to the hilt… in dollars. When Greenspan started slashing rates in 2001, investors around the world had been able to borrow cheap US dollars and park them in higher yielding assets abroad.
This global carry trade helped produce huge returns in emerging financial markets as investors borrowed four to six times their dollar equity at 2% to 8% and invested in China at 20%+.
When those markets began to melt down, however, the dollar loans needed to be repaid, and investors went rushing back into the dollar.
The dollar sat atop its altar for about six-months from September 2008 through March 2009, at which point risk tolerance reversed and the dollar began steadily losing ground again.
When European sovereign debt woes surfaced later that year (and in earnest in early 2010), the dollar surged once again… but that time it was a little different.
Sure, the dollar rallied against the euro and other European currencies… but gold rose as well. I remember writing about this last year, suggesting that the simultaneous rise in both the dollar and gold indicated the market’s changing attitude towards what it considered a ‘safe haven.’
Clearly the dollar was beginning to fall out of favor.
Fast forward to today. Mubarak. Gaddafi. Khalifa. Al Said. Ben Ali. Etc. There is no shortage of turmoil right now… yet we are seeing the dollar get clobbered while gold, silver, and smaller currencies like the Swiss franc rise. This represents a major shift in the way that the market views risk.
This blogger disagrees. Rather, as it did last week, it puts this shift in investor perception down to the ‘Bernanke Put’. When all bad news is simply a reason for more quantitative easing, then it is good news for liquidity driven markets and a falling dollar. Fed watcher, Tim Duy, is a prime example today:
The recent surge in oil has been a blow to my rising optimism. With this surge coming on the heels of accelerating US activity, monetary policymakers will offer some concern over the inflationary impact. Recent history, however, suggests the opposite – that unless the tide of rising commodity prices is soon arrested, Fed officials will find themselves faced with the prospect of yet another round of quantitative easing.
Markets know that the Fed only carries a large hammer and that, therefore, everything looks like a nail.
So what does this mean? Just this. The risks involved in the flight to safety trade have shifted, yes. But with the $US still the global reserve currency and one side of sqillions of daily trades around forex, commodities and cross border flows, it isn’t going anywhere. The shift in risk has only been sufficient to push the flight to safety outward until this, or some other crisis, is of sufficient magnitude to force dollar retrenchment.
Sovereign Man’s own description of cross border flows is the giveaway:
The other big reason for the dollar’s 2008 surge was that many of the world’s financial markets were leveraged to the hilt… in dollars. When Greenspan started slashing rates in 2001, investors around the world had been able to borrow cheap US dollars and park them in higher yielding assets abroad.
This global carry trade helped produce huge returns in emerging financial markets as investors borrowed four to six times their dollar equity at 2% to 8% and invested in China at 20%+.
Are you telling me that ZIRP and QEs I and II haven’t reinforced this dynamic?
This blogger agrees that precious metals will enjoy support so long as the crisis remains contained. But if it erupts in Saudi for instance or pushes on to China, and a genuine global recession threatens, then King Dollar will be back overnight, and gold will get hammered, along with the entire commodities complex.
