This link has been bookmarked by 3 people . It was first bookmarked on 05 Oct 2008, by Michael.
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06 Oct 08
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05 Oct 08
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The dollar hasn’t fallen along with the US stocks, US Treasury yields or US employment. There is now a broad consensus that the US is currently in a recession, something that might be expected to lead to a fall in the dollar.
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But the dollar, instead, has rallied. Against the euro. But also against a host of Asian currencies and commodity plays like Brazil and Russia. And it is soaring against the Icelandic Krona …
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Of course, there is now a new dynamic at play as well — namely mounting evidence of a broad global slowdown, and a sharp slowdown in Europe.
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But there is also reason to think that the dollar’s current strength reflects something other than the United States relative economic fundamentals. A recent research piece from Sophia Drossos and Yilin Nie of Morgan Stanley argues that global deleveraging is a major current source of support for the dollar.
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Drossos and Nie note that US banks have grown reluctant to lend to banks abroad — and many banks abroad have significant holdings of dollar debt and thus need dollar financing.
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As US-based institutions have scaled back their overseas lending, the premium for USD LIBOR has increased significantly.”
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The solution to a world where US banks won’t lend to the global funding market? Simple, the US central bank lends dollars to European central banks who lend dollars to their banks — dollars that European banks can no longer get from US banks.
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In other words, the US became the new Japan after the Fed’s rate cuts — despite a large current account deficit.
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The net result, though, has been rather surprising in a lot of ways: dollar strength amid US economic and financial weakness. I at least don’t think we really know what the long-term impact of the current crisis will be on the dollar.
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We still don’t know what will happen once the forced buyers of dollars by actors scrambling to repay dollar debts ends. The US will likely still have a sizeable external deficit that needs to be financed for a while longer, which could drag the dollar down. On the other hand, the US won’t be the only country in a recession.
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