According to Sir Isaac Newton, ``To every action there is an equal and opposite reaction”.
In terms of the US dollar index, Newton’s Third Law of Motion seems at work.
The US dollar index remarkably spiked just as after the Lehman Bros declared bankruptcy last September 15. But has surrendered more than three-fifths of its most of recent gains, with the gist of these losses surfacing during the past two weeks.
Courtesy of Bespoke InvestmentBespoke Invest notes that ``The US Dollar index fell another 2.2% today for its biggest 6-day decline ever…the current 6-day decline of 8.07% tops the prior record decline of -7.48% set back in September of 1985. If it's not one asset falling these days, there's sure to be another.”
So the amazing rise has now been equally met by an astounding fall. The question is if the recent decline will wipe out the entire gains accrued during the September-October rump.
Yet, some suggest that the US dollar is either in a long term bull market or will remain cyclically strong because of the present environment deleveraging, recession, risk aversion, narrowing growth differentials and the US dollar as reserve status.
While these factors may have, to varying degrees contributed, to the US dollar’s recent strength, we have long argued (see Demystifying the US Dollar’s Vitality) that deleveraging and the unwinding carry trade seem to be the critical binding force in pushing up the US dollar especially against Asian and other currencies, aside from the collapsing global financial markets and commodities.
Courtesy of Casey Research Charts
The post Lehman bankruptcy sent foreign buyers, mostly central banks, scrambling into US treasuries (US $147 billion-Casey Research) which drove yields to historical record levels and even to “negative yields” (see Living In Interesting Times).
The credit bust resulted to a dysfunctional banking system in the US, which caused global banks and Emerging Market economies to jostle for US dollars for mostly purposes of payment/settlement and or for capital building.
Thus, the fear factor or risk aversion and magnified status of the US dollar as the world’s currency reserve have basically been an offshoot to the massive debt deflation process. Debt deflation accounted for as the cause, all the rest were attendant actions or the effects.
And as the deleveraging eases, the US dollar should likewise reflect on its intrinsic economic weakness (yes, the US is the epicenter of today’s woes and unlikely representative of “safehaven” status) and the expansive inflationary actions undertaken by its policy makers (Dr. Jekyll and Mr. Hyde- Bernanke doing a Dr. Gideon Gono-see Zimbabwe’s Gono Lauds US and UK For "Seeing the Light" and "Making Positive Difference").
We don’t share the view that the US will recover first simply because it is experiencing enormous structural internal changes coming from an imploding bubble, which will fundamentally alter the country’s political economic landscape, aside from the reverberating weaknesses from its external linkages (exports or capital flows).
Even, Gao Xiqing president of the China Investment Corporation, which manages “only” about $200billion of the country’s foreign assets, recently observed of such fundamental shifts. In an interview with James Fallows at the Atlantic Magazine, Mr. Gao said,
``The overall financial situation in the U.S. is changing, and that’s what we don’t know about. It’s going to be changed fundamentally in many ways.
``Think about the way we’ve been living the past 30 years. Thirty years ago, the leverage of the investment banks was like 4-to-1, 5-to-1. Today, it’s 30-to-1. This is not just a change of numbers. This is a change of fundamental thinking.” (bold highlight mine)
Also, we do not share the view that plain recession or risk aversion will lead to a support in the US dollar. For instance, Pension funds, which for some should serve as pillars for the vitality of the US dollar, seem to have been impacted by forces that should help not weaken the US dollar, such as
1) the economic weakness that poked big holes in corporate pension funding...
This from Businessweek,
``In pooling together assets from many different corporations, a multi-employer plan should minimize the risk of any one company's not paying its pension tab, since it can tap other companies in the plan to make up for the shortfall. But something unexpected is happening now: As the recession grinds on, companies in a broad swath of industries, from transportation and manufacturing to food services and lodging, are going out of business and have stopped making their pension payments. That has left the remaining companies—healthy or not—with the burden of making up for the massive shortfalls. "The multi-employer plan is a great model as long as all of the companies stay alive and grow," says William D. Zollars, CEO of trucking giant YRC Worldwide, which participates in such plans. "But the way the current plans are structured, you not only pay for your employees but all the orphans whose employers have gone out of business."
``To prop up multi-employer plans, companies will have to dip into profits, which could force them to tamp down salaries and bonuses, cut jobs, and slash capital spending. It's a vicious circle: The bigger the shortfalls in coming months, the more they will weigh on the already slumping U.S. economy—which will only make the pension situation worse.
courtesy of Businessweek2) severe mark down of asset values in the portfolios of Pension funds...
Again from Businessweek ``At least some of the blame for the nation's pension woes lies with Washington, which has unwittingly tied the hands of companies with single- or multi-employer plans. Under the 2006 Pension Protection Act that's just now taking effect, employers must ensure their pension plans have enough money on hand to cover current and future benefits. If a plan is significantly underfunded—meaning its obligations exceed its assets—the company or companies must make up the difference within a certain number of years.
``Talk about bad timing. The legislation was meant to force corporations to shore up their plans so that the government wouldn't have to bail them out. But no one foresaw the great bear market of 2008. Now, just as the new pension rules are kicking in, investment portfolios are plunging. The nation's largest pension plans in late October had just 85 cents of assets for every $1 of current and future obligations, according to Standard & Poor's and that gap, a record $204 billion, has likely increased with November's stock market swoon. Goldman Sachs estimates that companies will be forced to boost their pension contributions to $40 billion in 2009, from about $18 billion this year….
``Taxpayers could find themselves picking up the tab, precisely the scenario lawmakers tried to avoid. The Pension Benefit Guaranty Corp., a federal government agency, was created in the 1970s to manage the pension assets of bankrupt companies. In recent years the PBGC assumed the benefits of steel giants like Bethlehem Steel and airlines such as United Airlines and Delta. But the PBGC is also hurting, with just $69 billion on hand and $80 billion worth of obligations. Should another big pension provider go under, the PBGC might need more public funding. "We are always trying to be prepared for the future," says Charles Millard, the PBGC's director. "We regularly update our contingency plans and review the funded status of plans and industries that concern us."
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