by Calculated Risk on 10/03/2007 08:28:00 PM

From the Telegraph: Dollar's double blow from Vietnam and Qatar

The Saigon Times said this morning that the State Bank of Vietnam was abandoning the attempt to hold down the Vietnamese currency through heavy purchases of dollars. The policy is causing the economy to overheat, driving up inflation to 8.8pc.

Vietnam, which has mid-sized reserves of $40bn, is seen as weather vane for the bigger Asian powers.

...Separately, the gas-rich Gulf state of Qatar announced that it had cut the dollar holdings of its $50bn sovereign wealth fund from 99pc to 40pc, switching into investments in China, Japan, and emerging Asia.
..
The drastic shift by the Qatar Investment Authority is a warning that petro-dollar powers with some $3,500bn under management may pull the plug on the heavily endebted US economy.

An insightful blog to read on these issues is Brad Setser's Blog; in his own words, Brad has been "reserve-obsessed for quite some time now".

by Calculated Risk on 9/20/2007 03:07:00 PM

The following graph shows the U.S. trade deficit as a percent of GDP compared to the Fed Nominal Major Currencies Dollar Index.

NOTE: The trade deficit as a percent of GDP is presented as a positive number (for easier comparison to the dollar index). The 2007 trade deficit is estimated at 5.1% of GDP. The 2007 currency index is set to the Sept value.

Click on graph for larger image.

The common pattern is a currency strengthens and the trade deficit increases. Some time after the currency peaks, the trade deficit peaks. And that is followed by a bottom in the currency. There are other factors, but that is the common pattern.

The recent increase, and extraordinary size of the U.S. trade deficit, was probably related to the housing bubble and mortgage equity withdrawal (MEW). Now that MEW is generally declining, and the U.S. economy weakening, the U.S. trade deficit will probably continue to decline.

If the trade deficit has peaked, the dollar is probably much closer to the bottom than the top. I know this may seem like heresy, especially given recent events.

The biggest short term concern is that MEW will collapse, and the trade imbalance will unwind faster than expected. A "Wile E. Coyote moment"! (see Krugman: Will There be a Dollar Crisis? )

Also, from the WSJ: World Economy in Flux As America Downshifts

"We're definitely poised to have some significant rebalancing" of trade, says Harvard University economist Kenneth Rogoff, a former chief economist for the International Monetary Fund. He had been expecting the account deficit to shrink "by maybe half a percentage point of GDP over the next twelve months. Now it seems likely it will go down by 1.5 percentage points." And, he adds, "We could see something more rapid."

Something "more rapid" could be painful. Since Americans have financed their prosperity with borrowed money, reversing that habit means a period of living less opulently.

If foreign money turns scarce and the trade deficit narrows suddenly, Americans could face a tumbling dollar, soaring interest rates and an economic downturn. That could send shock waves back through Europe and Asia if their own consumers don't make up for lost demand from the U.S., the world's largest national economy.

If it happens more gradually, the recent run of American prosperity may continue, in a more subdued way.

by Calculated Risk on 9/19/2007 06:19:00 PM

From The Telegraph: Fears of dollar collapse as Saudis take fright

Saudi Arabia has refused to cut interest rates in lockstep with the US Federal Reserve for the first time, signalling that the oil-rich Gulf kingdom is preparing to break the dollar currency peg in a move that risks setting off a stampede out of the dollar across the Middle East.

"This is a very dangerous situation for the dollar," said Hans Redeker, currency chief at BNP Paribas.

Saudi Arabia has $800bn (£400bn) in their future generation fund, and the entire region has $3,500bn under management. They face an inflationary threat and do not want to import an interest rate policy set for the recessionary conditions in the United States," he said.

The Saudi central bank said today that it would take "appropriate measures" to halt huge capital inflows into the country, but analysts say this policy is unsustainable and will inevitably lead to the collapse of the dollar peg.

This ties back to my post yesterday on a possible vicious cycle. To attract sufficient foreign capital flows to cover the U.S. current account deficit, interest rates in the U.S. may need to rise significantly.

The Greenspan conundrum was that long rates didn't rise at the Fed Funds rate was increased. Bernanke's conundrum may be that long rates don't fall (or maybe even increase) as he lowers the Fed Funds rate!