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Wednesday February 16, 2005 - 11:24:23 GMT
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Fate of the dollar


“What is Fate?” Nasrudin was asked by a scholar.
“An endless succession of intertwined events, each influencing the other.”
“That is hardly a satisfactory answer. I believe in cause and effect.”
“Very well, “ said the Mulla, “look at that.” He pointed to a procession passing in the street.
“That man is being taken to be hanged. Is that because someone gave him a silver piece and enabled him to buy the knife with which he committed the murder; or because someone saw him do it; or because nobody stopped him?”

The Legend of Nasrudin

FX Trading

Can currency price action over time be defined any better than the Mulla’s definition of fate: “An endless succession of intertwined events, each influencing the other.”?

All eyes and ears, and probably a lot of bets in many markets, are trained on the once lowly disciple of Ayn Rand--Mr. Alan Greenspan. I’m not sure what Miss Rand would have to say about our current culture (that for another time and place), but I’m sure she would marvel at the complex web that global capitalism has woven.

Each day we attempt to forecast price action based on this intertwined web of relationships. And it’s why we look at charts. It’s much easier to see patterns on a chart, than get our arms around things such as: Japan’s recession, UK employment, a rising dollar on lower capital flow, a rising euro on German unemployment. The “big brain” types imply they can see and dissect cause and effect. They seem especially good at it, after the effect. But there are times, when we can view at least the outline of cause and effect.

I often receive email questioning why I am bullish on the dollar over the intermediate-term time frame. I provide the usual rationales to fit my story:

• Positive US yield differential
• Strong “relative” US economic growth
• Plenty of dollar bearishness still in the market
• Action “at the margin” by the Bush administration on the budget deficit problem
• A realization that the a falling dollar is not the key to balancing the US current account

But in the background I keep watching for what I believe is the catalyst that will lead to another strong leg-up in the dollar. And this catalyst is linked tightly with the level of “hawkishness” Mr. Greenspan displays going forward—the China Bubble. And though China is the darling of the investment elite, make no mistake, it is a bubble.

We all know that bubbles end badly—we just don’t know when. But as Mr. G tightens down the monetary screws, we inch closer and closer to fate! Should fate prevail, a whole bunch of money will come rushing back onto the shores of good old Uncle Sam, providing a tidy little boost for the buck.

“China, appears to be experiencing the biggest liquidity bubble in its history. The hot money inflow totaled US$656 billion in 2003–04, which has made money cheaper in Asia than in the US. The hot money turns into demand, primarily through property speculation.

“I believe this global liquidity bubble, with China at its heart and property and hedge funds as its two lungs, will burst if: 1) the Fed raises interest rate quickly; 2) overcapacity overwhelms speculative demand, or 3) a financial accident occurs that decreases risk appetite.”

Andy Xie, Morgan Stanley

Thank you Mr. Xie! Another brilliant summation.

This is the reason the Chinese have put “revaluation” on hold. Despite the growing consensus belief that a soft-landing is assured, China is still mired in Bubblesville.

Taking Mr. Xies points in reverse order: 3) financial accident—for sake of familiarity, let’s call these Black Swan events. We can’t predict them, but we MUST understand they are always lingering out there at the edge when speculation reaches fever pitch. 2) Chinese overcapacity—heck, even the Chinese government knows overcapacity in some sectors is running rampant. 1) The Fed raises rates quickly—the wild card…but is it really that wild?

One of Andy’s colleagues, Richard Berner at Morgan, sees Mr. G’s hawkish side winning the day:

“Amid these crosscurrents, there is scant reason for Fed Chairman Greenspan to signal any change to the Fed’s game plan when he testifies before Congress this week. Despite the fears of some officials that inflation could pick up more quickly, recent Fed speeches and statements still suggest that “accommodation can be removed at a measured pace.” And following 150 basis points of tightening, monetary policy is closer to everyone’s appraisal of neutrality. Yet few officials would deny that there is still work to do, especially if inflation risks do escalate. Thus, while a slower pace of tightening is likely at some point, it’s premature to signal such a change. For a market priced to a Fed that sharply slows the pace no later than June, Mr. Greenspan’s comments may thus sound downright hawkish.”

Though it appears the recent back-up in the dollar should technically have more to go on the downside, the preponderance of intertwined relationships, coupled with our inability to link cause and effect—effectively—tells us that anything can happen. And that’s why they call it a market.

Jack Crooks


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