Word: dollarization
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...Less obvious is the support the dollar is getting from an unlikely quarter: global hedge funds and other nonbank financial entities. This shadow banking system has borrowed trillions of dollars to leverage its investments. But the crisis has triggered massive early loan repayments, and because these loans must be repaid in the U.S. currency, demand for the dollar has increased, driving up its value. It's not just hedge funds that are affected. Foreign banks, which hold $12 trillion in dollar assets and liabilities, are also in the process of deleveraging...
...this helps to explain why the dollar has been stronger lately. But with the U.S. Federal Reserve cutting interest rates again and the U.S. Mint running its printing presses overtime to fund rescue packages, won't the dollar tank soon? Probably not. As the Treasury Department's $700 billion bailout plan is implemented, banks should begin to be able to restructure their balance sheets and regain the capacity to make loans at interest rates that will be attractive at home and abroad. While a U.S. recession looks unavoidable, the stabilization of the financial system should allow a recovery to begin...
...what's really good for the dollar is China, which has a couple of solid reasons to help maintain the stability of the U.S. currency. One is that China is one of America's biggest creditors; the country holds some $519 billion in U.S. Treasury bills (second only to Japan's $593 billion), and it doesn't want to see these investments eroded by a slumping dollar. In addition, China is increasingly worried that an economic slump in the U.S. and Europe will curtail its export growth, dealing the Chinese economy a serious blow. To keep the prices...
...currency markets are complex ecosystems, it seems unlikely that countries such as China and Japan that have already loaned America trillions will stop buying U.S. government debt any time soon. They have relatively few tools at their disposal to keep their economies on track other than tending to the dollar exchange rate. China recognizes it has little choice but to go on financing the ballooning U.S. budget deficit by expanding its foreign-exchange reserves from $1.8 trillion to $2.3 trillion over the next 18 months...
...message to dollar bears is clear: the grimmer the headlines are, the more misleading they can be. Selling the dollar short because of the financial crisis is not a sure bet. All economic news is relative, and right now the news is bad all over the world. Over the next several months, the greenback could even begin to look like a safe harbor in the midst of the global economic storm...