Aug 5, 2011
The reliance upon the U.S. dollar as the world’s reserve currency and “safe haven” asset has created a perverse, but deeply entrenched, mindset among global investors. In fact, many believe the major financial players have no alternatives to owning U.S. debt and dollars. They argue that the market for U.S. dollars and Treasuries is the only financial pool large enough to handle the massive liquidity that sloshes around the globe on a daily basis. This idea makes a mass exodus from U.S. debt holdings seem impossible. This provides a nice explanation why the U.S. Treasury bonds can rally even while the government openly flirts with default and ratings agencies issue downgrades. But just because an illogical event occurs habitually does not mean it is logical or tenable.
The sophomoric reasoning behind the dollar “exceptionalism” argument is like assuming a stock can never fall unless a significant portion of shareholders decide to sell. In reality, a buyers strike is all that is needed to puncture a market. If the U.S. experienced just one disastrous Treasury auction, prices could nose-dive and yields could skyrocket across the board on all U.S. debt.
But the problem doesn’t just lie with the United States. Investors around the world are finally beginning to understand that central bank’s thirst for creating inflation, in order to keep their banks and governments solvent, will never be quenched.
This week, the Swiss government took action to weaken the surging franc by lowering interest rates and printing currency. The franc was pushed down briefly, but then snapped back. It’s hard to keep a good currency down. Similarly, the Bank of Japan announced that it won’t stand for Yen appreciation much longer and would likely soon intervene to buy dollars and weaken the Yen.
Meanwhile, problems at the overly indebted countries just get worse. Italian and Spanish debt yields are now following the upward spiral of Greek bonds (and hitting multi year highs). Italian ten-year notes have surged from just above 3% in late 2010 to well over 6% today. For a country whose debt to GDP ratio is currently over 120%, a doubling of interest rate expenses spells disaster.
This article was posted: Friday, August 5, 2011 at 3:29 am