Wednesday, January 14, 2015

$afety of the Haven

The current dollar-denominated deflation that everyone is focused on is really a dollar centric phenomenon. As Reuters, and the BIS have noted, if major currencies diverged from the dollar, a different scenario, ranging from stability to mild inflation is fully possible - but only if the trading behavior of that currency's economy could truly divorce itself from dollar interests.

Perhaps it is this strong marriage, bound by the vow of chapel Forex, that imbues the dollar with the traditional role of gold. Even with dollar denominated products made in economies where dollar strength has ignited hyperdeflation, dollar credits continued to be hoarded, starving the Forex of liquidity and perpetuating FOFOA's vicious cycle.
The vicious circle works like this. Foreigners settle some portion of international trade in dollars, and then they hold onto those dollars as a kind of final settlement, savings or reserves. This drains dollar liquidity from the foreign exchange which causes the dollar's exchange rate to rise. As the dollar's exchange rate rises, this causes foreigners to want to hold more dollars (because dollars are gaining purchasing power for them locally, not as a reward for hard work, but as a gift of timing) which drains even more dollar liquidity from the foreign exchange which causes the dollar to rise even more and so on. 
Of course all FIRE SALES eventually end, and as "timing" is the key word here, we all know what will happen when all those pent-up dollars are faced with the decision by all who hold them that they need to be redeemed all at once, due to the "universally perceived right timing".

Speaking of perception ... it is merely the expectation of FED tightening that creates the perception of shrinking liquidity, and that perception (in our artificially managed paper world) is equally powerful to an actual real world liquidity drain. I wonder if that perception could change "all at once" if the physical world of deflation caused thoughts to change.

"Hurry Dollar shoppers, registers will be closing in ten minutes and our Spectacular Founders Sale will be OVER. All sales are final ... and as always ... Thank You for shopping America's Federal ReserveMart!"

2 comments:

  1. This has been bothering me all afternoon.
    Are you saying that because of less liquidity there is some sort of flight to safety that causes the demand for dollars to be higher, or because there is less supply than there was before it shifts the exchange price of dollars higher?
    I'm not trying to say you're wrong, just trying to understand the mechanism you're describing and that I've seen described elsewhere.
    My feeling was that say Russia decided to recycle less of their petrodollars into Treasuries, that demand for USTreasuries would decline, pushing interest rates up. Similarly if they are selling existing USD reserves.

    Thanks for any additional commentary you can provide.

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  2. Don't let it bother you - I could be wrong ... but ...

    I tend to agree with FOFOA that both of your questions/answers = YES ... counter-intuitive that it may ne. I also saw the ZH article about Russia ceasing petrodollar recycling and my first thought was that this would backfire (again, counter-intuitive that it may be).

    But I did pose the question: why wouldn't FED liquidity swaps de-escalate the dollar's rise? (though no one there seemed to think that a question pertaining to the post itself merited discussion).

    re: interest rates. Nothing anyone on planet earth can do affect interest rates with 200 plus trillion held by the US bailouty queens with the FED as their broker and US Treasury as their counter party. The entire derivatives complex must collapse for that hold to be released.

    re: liquidity, the full passage (I tend to agree with) you may have seen, but nonetheless:
    The dollar is on fire right now… 90.28 at the close! That should be a good thing for the dollar, right? I mean, look at the ruble. It goes down and the Russian state struggles while the Russian people panic. Meanwhile the dollar is up and everything's great in the US, from the stock market to the GDP. Up good, down bad, is that how it works? And why is the dollar rising when our trade deficit is still above $40B per month?

    Currency strength—a propensity to constantly rise—has always been the dollar's curse. It's why we print, to keep it from going up, because if we didn't, it would just go up up and away, all the way up to currency heaven. It is a characteristic of being the reserve currency, and it is a vicious circle that drives the dollar's exchange rate and our trade deficit up.

    The vicious circle works like this. Foreigners settle some portion of international trade in dollars, and then they hold onto those dollars as a kind of final settlement, savings or reserves. This drains dollar liquidity from the foreign exchange which causes the dollar's exchange rate to rise. As the dollar's exchange rate rises, this causes foreigners to want to hold more dollars (because dollars are gaining purchasing power for them locally, not as a reward for hard work, but as a gift of timing) which drains even more dollar liquidity from the foreign exchange which causes the dollar to rise even more and so on.

    This currency strength—the propensity to constantly rise—plagues the US economy by making our exports appear more expensive which reduces exports and we lose jobs and profits in the export sector. Meanwhile, it makes foreign imports appear cheaper than what we make for ourselves here at home which increases imports and we lose jobs and profits in the domestic economy. (The jobs and profits, BTW, are exported to our trading partners, sort of…)

    We combat this currency strength by printing (which actually means printing debt IOUs, i.e. borrowing more dollars into existence) and feeding a portion of that new liquidity into the foreign exchange where it's being drained by foreigners. Yet even if we print enough to keep the dollar from rising, it still causes our trade deficit to rise because of a net outflow of dollars, which causes us to lose jobs and profits in pretty much all sectors except the financial sector, which absolutely THRIVES on this "vicious circle".

    So the dollar's exchange rate is actually a function of our pouring new dollar liquidity into the FX versus their draining of dollar liquidity from the FX. If they are draining faster than we are pouring, the dollar will rise, like it's doing right now!


    I don't know if that makes sense my friend, and again, I do not know this to be indisputable or immutable, but ... I do find the overall logic of FOFOA to be as near infallible as anything I have read, short of A and FOA.

    May the flower of understanding impart wisdom to us all ...

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