Wednesday, 23 April 2014

Is it possible to break the Dollar's stranglehold?

That last run up from the bounce off support on the 14th April seems to have legs. There was a pull back from its high point yesterday but the signs are that today's trade will carry it higher. As you can imagine I'm feeling sick at losing the opportunity to make more out of the move. If only we could transport ourselves a couple of days into the future. But we can't so we have to frame our best guesses, make our choices and live with the consequences.

There will come a day when all that money, pumped in to shore up the US economy will shrivel up and we will have an almighty crash. If only I knew when that will be.

China prepares for a rainy day

Which takes me neatly back to the Dollar trap. What will become of all those reserves that are being built up by the emerging markets, especially China. These are savings put aside for a rainy day: to help them cope with consequence of a global crisis.

The scenario is this. Some thing will change sentiment and suddenly all those wealthy and institutional investors who have been happy to buy and own assets in developing markets  will have a change of heart and decide that the profitable home they found for their assets with in fast growing markets is not as safe as they thought. Result: a precipitous pull out and flee to safety. This flight of capital puts pressure on the developing countries' exchange rates which their governments cannot accept. They use their dollar reserves to prop up the market for their currencies - that is why they built up those reserves in the first place. Speculators shorting the currency, it is hoped, would be frightened off knowing that there is a wall of money which will prevent them getting their own way.

The follow through from this will be a battle over the value of the dollar. Investors fleeing to quality would push up the price of the dollar and push down the value of the more risky currencies. The central banks of the weak currency countries will support their own currencies' values by selling dollars. Another dollar trap, for all the action is likely to happen at once as a crash occurs. The drama will be played out in the commercial and investment banks which will be having to cope with sudden capital outflows which will devastate their balance sheets.

An effort is being made to improve the structure of the currency markets by broadening the range of currencies that are held as reserves. The IMF has a system of SDRs (Special Drawing Rights) which are on offer to countries as alternatives to the dollar as reserves. At present SDRs are a based on a combination of Dollars, Euros, Yen and Sterling. There is a suggestion that the Chinese currency should be added to this group, partly as a way to promote its importance as a reserve currency. Countries trading with China could hold the currency specifically to support their own rates. And China would not be obliged to go to the dollar find security. There are many hurdles to be jumped before the Chinese currency achieves this status.

Other markets will be sucked into the spiralling vortex

In a crashing international market stock and commodity markets will be impacted as worried investors run for the exits. It's not going to be a pretty sight.

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