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Tuesday June 2, 2009 - 14:02:38 GMT
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Forex Blog - BRICs Plan Boston Tea Party for USD…Risky Business

BRICs Plan Boston Tea Party for USD…Risky Business


No cooperation without representation is the clarion call of Russian leaders at the very least and increasingly the clarion call of fell BRIC states China and Brazil.  So far India is not making its views known.  But the message is clear, give us more say at the table or we will throw US dollars into the harbor.


Not even tea loving Boston democrats could ever think of life without tea as they tossed the commodity overboard. 


Similarly, recalcitrant BRIC states eager for an equal seat at GN, IMF, WTO, UN and WB table are not ready to go cold turkey on the US dollar.  After all they still hold massive quantities of the US currency and stand to lose lots if the currency crashes (why China can’t afford to let the yuan float – a 10% rise would wipe $200bln off its reserves in a stroke…30% is probably more likely yuan rise vs USD in a flexible regime). 


However, as Bear and Lehman collapses brought home, what is unthinkable on Monday is reality by Friday when there is a run…mob rule in financial markets is darn hard to turn around.  The more BRIC states like Russia use the politics of currency and a beaten down dollar to push its broader geopolitical agenda (rest assured sustainable US deficits and debt are not nearly as important as BRIC agendas for places like Tibet, Georgia and the Amazon).


In currency politics, history tells us that attacks on the US dollar reserve currency status are temporary – ebb and flow with the business and political cycles (domestic needs).  So I am not a believer in a GBP post-war outcome for the USD.


But I also find it troubling that South Korea’s main state pension fund announced last week it was no longer going to buy US Treasuries because returns were too low (it did not say it would sell USD) and at a meeting of 16 Asian central banks in Jakarta in May officials discussed the need to diversify out of USD and US Treasuries and into each others currencies and bond markets (these banks manage about $1trln in reserves (China and Japan not included).   


What has me pulling my hair out is the sense of complacency in Washington over the dollar and pretty much all things financial…Geithner again today said the back up in US Treasury yields reflected markets pricing out the risk of deflation (normalization).  Looking at what markets are doing to USD and UST (Treasuries), I don’t know whether to wind my ass or scratch my watch.  I don’t see this as a normalization but the demise of any hopes of a recovery outside of whatever the public sector (US government) can provide with its myriad of support programs (recall life insurance companies are the latest to get the government life line…are hedge funds and mutual funds next?).  Buying $1.25trln in GSE MBS and debt and another $300bln in US Treasuries was aimed at keeping rates low (in the face of soaring debt issuance).  Low borrowing costs are the fuel of a sustainable recovery and borrowing costs away from Federal guarantees are running up.  Refinancing has collapsed.  Yes stocks have soared in value and to a large extent this reflects success of massive government intervention (mostly from the Fed) to restore confidence and make holding cash painful.  But how real is the 40% rebound in stocks?  Q1 corporate earnings jumped, but this was due to slashing costs from employees to lease rates.  Who is selling more units?  A cost-led surge in profits is a form of corporate cannibalism all else being equal.


So what is happening in rates and FX is much less about a normalization in expectations/confidence and much more about fear/uncertainty and this is what has BRICs panties in a bunch and why Geithner felt obliged to rush to China, the top banker for the USA


Unless policy can be reshaped to address the worries of BRICs, and bond and forex traders everywhere, a crashing USD (mirror image of soaring commodity prices – an indirect tax on firms and households) and rising US Treasury yields (rising global yields), this recovery will end up looking more like a W than a V…with a quarter or two of government sponsored GDP growth and then back down.     However, this will require an ever larger role for government in setting rates, not simply pumping up equity prices (underwriting the “private” banking and shadow banking sector), and the USD…yes the mother of all bond, MBS and USD intervention (not talking buying dollars to drive it up, just to prevent a run and conveniently would be a way for the Fed to start mopping up liquidity…if only US official had a stockpile of foreign currency reserves to draw upon…just has swap lines beyond nominal euro and yen holdings).


The dollar may not crash and burn but it has the hallmarks of becoming a disorderly decline that leaves US asset markets vulnerable.  And in time even stocks would fall victim to a disorderly USD decline…and that is newsworthy in our reverse spyglass view of the world (equity tail wags bond/dollar body). 


BRICs may not ever intentionally push the dollar over the edge, but unintentionally is a distinct possibility.  And right now the rhetoric is palpable and when BRIC meets for a summit in Russia June 16 look for the volume dial to go to ten and the dollar to wobble. With Putin/Medvedev KGB alumni association running the event and poking the US in the eye a chief objective, June 16 should be a major dollar event.  US Treasury may need China’s cooler head to prevail June 16 more than at anytime in decades.


David Gilmore


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