Economics, Politics, Social Commentary and occasionally Superstring Theory.

Tuesday, November 30, 2004

Why Hasn't The Other Shoe Dropped Yet?

Alot of people have been wondering why the U.S. dollar is only sliding now, after a few years of the government printing a mountain of money. After all, it should simply be a matter of supply and demand: more dollars on the market means less demand for them and scarcity equals value. So, why just now? Brad DeLong thinks the private holders are waiting for the central banks to make a move, because the value of betting against the dollar before they do is small. The bond market, however, remains a mystery. My proverbial two cents (if worth even that):

1. I think some of the central banks have already started making these moves through private channels (undisclosed principal transactions.) Russia has even made a public announcement of its abandonment of the dollar.

2. The holders of most of the debt (Japan and China, respectively) cannot afford to let the dollar go into a free fall. Their economies are too tied into U.S. demand. Let's focus on China. Because the Chinese peg their currency to the dollar, slides in one are slides in both. This smooths out (theoretically) any demand problems for Chinese exports in the U.S. and vice versa. However, it makes third country imports into China more expensive. This lowers their savings rate, as more Chinese liquidate savings into consumption to pay for the higher cost goods. Their lower savings rate means they can't purchase as much U.S. debt. U.S. debt is partially driving U.S. demand for Chinese exports, and a drop in exports leads to increased unemployment. So, China would be facing lower export demand, higher real prices for imports, and increased unemployment. As long as Chinese savings is financing U.S. consumption of Chinese exports, the Chinese will continue to lend as much as they can. However, stories like this don't bode well.

3. It's also possible that foreign central banks thought Kerry had more credibility than Bush on reducing the deficit and are now reacting accordingly to a Bush re-election. A run on a currency typically trickles for a while until something happens that unleased the tsunami. It's possible that we're just watching the trickle right now and the tsunami is on its way.

4. I share Brad's mystification as to the bond market. The only other explanation I can give is that there's a capital glut right now that's giving bond traders a cushion against future risk. Other than that, no clue.


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