Friday 20 February 2009

When will the dollar’s cracks show?

1 comment:

Guanyu said...

When will the dollar’s cracks show?

20 February 2009

Looking at exchange rates alone, one could easily be forgiven for thinking that the US economy must be going great guns, while just about every other country’s is down in the dumps. The reality is, of course, quite different.

Five per cent losses per session have become almost commonplace on Wall Street; US banks’ stock prices are at levels which make them almost junk; US carmakers told us this week they need billions more to escape bankruptcy; and the indefatigable US consumer’s spending power has gone the way of falling US prices. Worse, this month’s latest US$2 trillion effort to rescue the US banking sector and revitalise the US economy has been greeted with an ample dose of scepticism.

Yet the US dollar has actually strengthened against just about everything out there since the start of 2009, except for gold. Most will understand that with exports collapsing in the face of a global slowdown, the currency of an Asian exporter like South Korea has slumped more than 10 per cent in less than two months, or that the US dollar is just a shade shy of its 2008 highs in Singapore dollar terms.

But there are many others. Even a major alternative like the euro has now fallen more than 10 per cent since early January, while the yen is more than 2 per cent weaker against the US dollar. There was even talk this week that the Chinese government would love to see the once-unstoppable yuan fall back towards a rate of seven yuan per US dollar.

The stock explanations we hear for such US dollar resilience include its premier status as the world’s reserve currency, and the depth of its capital markets. Also mentioned is the positive impact of US fund managers selling overseas assets to plug losses at home and to pay for hurried redemptions by nervous investors.

That said, the rumbles have begun, focusing on one central concern: How will the US pay for its massive trillion-dollar bailouts and fiscal stimulus packages as well as finance two ongoing wars?

Officially, US government debt is still a manageable 60-70 per cent of US GDP. Unofficially, insiders warn that if we include longer-term considerations like unfunded pensions and other social security liabilities, the number could amount to more than four times US GDP - a whopping US$60 trillion or so.

And with yields little more than 1-3 per cent these days, things could get very rough if foreign holders of some US$15-20 trillion of US Treasury debt start to bail out at the same time. That’s when the US dollar could really start to tank big-time.

HSBC researchers suggest that we watch the price of credit default swaps (CDS) on sovereign risks. The value of currencies such as the euro have tended to move in sync with such CDS prices. So far, the US dollar’s unique status has all but exempted it from such sell-offs, but something like a credit rating downgrade might just change that pleasant status quo in a hurry.