Sunday, August 30, 2009

Two items of interest for dollar followers

There were two news items this week that have potentially substantial implications for the US dollar.

The first is that a new political party, the Democratic Party of Japan, has swept into power in a landslide election victory. While these results will not be a surprise to the markets, it is a potential concern for the dollar. This is because the DPJ has a much cooler stance on Japan's relationship with the US, and certain officials have taken the stance that Japan should reduce its exposure to dollar holdings.
More recently, officials from the DPJ have seemed more reticent about the possibility of dumping the dollar, focusing as usual on the assumed valuation effects of their savings. I still don't understand how they are savings if the act of spending them reduces their value. This truth underlies how the currency manipulators of the world will get their comeuppance. This election is not a direct threat to the US dollar, but the new power in Japan at least pays lip service to increased flexibility in their relationship with the US and monetary issues. If you want to read a op-ed piece from the leader of the party you can do so here:

The second item has to do with announcements made by the Chinese sovereign wealth fund CIC.
It appears that the CIC is starting to increase its risk exposure, and thus far the investments seem to favor non-US entities. A short list of the possible investment already made include Teck Resources limited, Canada
and Songbird Estates PLC, England. The fund also has been active in the domestic banking market, and is rumored to be looking at Japanese equities. The reason that this has implications for the US dollar is simply a matter of asset preferences. If the CIC uses cash equivalents (the majority of which are dollars) to purchase equity and to finance debt (the majority of which are not denominated in dollars) then this will depreciate the dollar, all else equal. We saw the reverse of this in the financial crisis last fall when US and non-US entities both liquidated non-US investments in order to cover dollar obligations and to raise dollar liquidity. So long as we avoid a further financial crisis, the tide on asset preferences will now be heading in the other direction, and the CIC purchases and planned purchases are an excellent and important example of this.

From a technical perspective, the dollar is in an ambiguous stance. The recent break below below 78.5 in the dollar index was short lived; however, the rally since then has also been lackluster. We now sit at the support area around 78.5. As trading picks up in the next couple weeks, we will likely see a new trend develop. A higher dollar is likely (but not a sure thing) if the market perception starts to lean toward a further deflationary contraction of the economy. Likewise, a lower dollar is likely if the market perception continues to expect a market expansion.

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