Peerless tries to explain the US$ weakness

I wrote the paragraphs below as an assessment on the US$ Outlook to my clients.  Since the report contains info useful to Macroeconomics as well, I thought it would be nice to include it as a blog post.

"Nuclear Quantitative Easing"

By way of a quick background, the term "Quantitative Easing" comes from the policy pursued by the Bank of Japan in the 1990's when they pumped vast amounts into the banking system to facilitate loans in credit in the wake of their Economic Crisis.  With the events of the Subprime Crisis crippling the US and the Worlds' Major Economies, we are seeing a return to the Quantitative Easing School of Macroeconomic policy.  

With that definition out of the way, the US$ Index saw a bounce from its lows in August 2008 to recent Highs in the beginning of March, 2009.  In fact much of its rally had taken place during the Lehman Brothers Default as well as the AIG crisis.  The reason for this strength had nothing to do with fundamentals but was simply the unwinding of the "Yen Carry Trade" where multinationals would borrow money in Japanese Yen at low interest rates and then lend in US markets at higher levels.  However, the US Treasury announced on 18 March a plan to add $1.1 TRILLION to the=2 0US Monetary Reserves over the course of the next year (Including $300 billion over the next 6 months).  When one considers that the US Monetary base is already up $1 Trillion from July 2008 until now as well the fact US Treasury Debt has grown from $6.5 Trillion in 2003 to $11 Trillion presently, the word Nuclear has been attached to Quantitative Easing by many other analysts.  Simply put, The US is printing money at a rate which could outstrip demand for its debt instruments (T Bills, etc) and setting the stage for huge inflationary concerns.  In fact, the yield for 30 year treasuries (which move inversely to principal value) is expected to be as high as 4.6%.

Since of course, it would be akin to yelling "Fire" in a crowded movie theater, the Central Banks of the World are trying to talk down this huge increase in US$ Money Supply.  The most recent US Treasury Report that lists the total debt flows in the US and what nations are investing in them shows a net outflow of $91 billion.  Yet, the individual breakdown has China increasing to a record value of US debt held and also has the Russian Federation at an all time high.  However, in spite of US=2 0statistics showing Russia purchasing $30 billion of US Debt since August 2008, their net FX reserves decreased $221 billion and the US$ share of the total Russian FX reserves is down to 41% from 47.5% (stats from Bank Rossii). Simply stated, the numbers don't exactly reconcile with each other and we would appreciate feedback from any of our readers more familiar with the situation.  

So, the question becomes, what exactly keeps the US$ from a total meltdown? The answer is that the system is now too large to fail.  The last thing China and Japan want to have happen is to see yields on their collateral rise sharply (remember the inverse relation between yield and principal) so they are not speaking out too strongly yet.  Also, the fact the Gulf Arab Nations insist on being paid for Oil in US$ serves in a way to make sure the US$ is on an "Oil Standard".  It should be noted that this second point is of great chagrin to the Fundamentalist Regime in Iran as well as other radical Islamists who feel Governments in places such as Saudi Arabia are merely "de-facto" extensions of the US and its policies.  

In the future, we expect to see a very gradual movement away from pricing in US$ as leaders such as Mr. Luiz Ignacio Lula da Silva of Brazil are calling for direct exchange of currencies between China and Brazil on commodity trades.  However, the short term result of the 'Nuclear Quantitative Easing" Policy will mean cheaper commodities on a US$ basis and spark an interest in buying by large end users such as China.  In fact, Beijing is in the process of allocating $4 trillion Yuan (approx $500 billion) for the building of infrastructure projects in China.  The direct result of which can be seen in the jump in the Baltic Freight Index to a 7-month high due to Chinese purchases of Steel, Iron Ore, Copper, etc.