A Question of Degree:

I wrote some time ago of “The Race to the Bottom” wherein the four mega currencies of the World, namely the US Dollar, the Yen the Euro, and the Pound Sterling were being manipulated by their central banks in a race to inflate (as opposed to deflate) relative values and stimulate consumer demand. The strategy is accomplished by ‘quantitative easing’ new words for printing money.

Now it appears as though the US Dollar may have lost the race and is now increasing in value compared to Gold and the Euro. The currency markets seem to be telling us that,compared to everyone else, (that is with the exception of China where nobody really knows) the prospects for the US Economy are better than say Europe and Japan.

The World is awash in trillions of US Dollars that have now been the International medium of exchange for seventy years.  During the later part of this period, these dollars have been recycled by immense balance of payments deficits run by the US, and by the issuance sovereign (or national) debt to finance America’s wars of retribution. Its’ all rather like a huge bathtub, lets call it the ‘tub’, with the dollars all sloshing around,and the taps always on. The dollars in this tub are extremely volatile and will seek safe haven and yield in the blink of an eye.

The ‘Tub’ is the playground of the traders, more particularly the commodity and currency traders. This is where the action is that sees trillions of dollars change hands every single day. Commodities, led by oil, have been linked to US Dollar in a global economy where buyers and sellers now try to lock in returns on future sales. It was not always so.

Back in the good old days of dollar hegemony, just about all commodities were the subject of long-term agreements, that relied on fixed exchange rates, that were pegged in a narrow band. Then came the NIxon Shock (the de-indexing of gold) and the stagflation of the 70’s and all hell broke loose. Marc Rich, founder of what is now called Glencore, the largest trading company in the World, almost singlehandedly started the spot market for oil and things have never been the same. Hence the ‘tub’

In the past eighteen months two very significant events have occurred that have had the effect of tightening the taps in the bathtub and thereby raising the value of the US Dollar when compared to the Yen, the Euro, and gold.

First and most significant, domestic oil production in continental USA had increased by nearly two million barrels a day.This marginal production has displaced imports of the same amount ( a $200 million credit/ day to the balance of payments) At the same time China, having nearly filled its strategic reserve, has cut back on purchases thereby creating a temporary glut of crude oil on the spot market.

The possible knock-on result of converting the US Economy from a net importer to net exporter of oil maybe enough by itself to defer, for now, the  re-evaluation of the Dollar. Despite the utopian desire to reduce carbon emissions, and oil consumption, it is still very much all about ‘oil’; those that have it will prosper, while those who do not will struggle. Oil is still priced in US Dollars so the effect on net pricing will be even greater.

The second event is an enormous reduction in military spending by the US, as the Wars in Iraq and Afghanistan are wound down, allowing for a one-third reduction in the current account deficit (or the need to borrow the same amount) This again, if continued, can have a salutary  effect on the value of the dollar.

So right now the future looks bright for the dollar, but it is very much a matter of degree. If the Fed screws up and does not start to raise interest rates soon enough, inflation or more likely stagflation, can quickly ruin the party. And what of the promise to re-purchase the trillions of dollars in US Treasury Bonds involved in ‘quantitative easing’. Will the Fed resist pressure from Congress, to keep the good times coming, and actually start to shrink the money supply.

Stay tuned.

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