The World Wants Dollars – Deflation – and a Run on Many Currencies

It is simply impossible to keep up with what is happening in the financial world, nevermind the the real economy. I am so overwhelmed by the magnitude of the actions that are being taken, and lie awake at night trying to think about the short term and long term consequences. Today what grabbed my attention besides the governments $540 billion program to buy commerical paper, the crashing equity markets, and the horrible earnings annoucements, was the mind-blowing currencies swings.
I am Canadian and have assets in Canada. There was a time not so long ago when a Canadian dollar was worth more than a US dollar, and it has since moved 25%! 25 %! Only a few short weeks ago at the local Tim Horton’s in Kelowna BC my parents friends were telling me about the houses they were planning to buy in Arizona now that the prices were down so much. Now I am hearing people are walking away from their deposits. The good news is Canadian real estate is looking very attractive to Americans, but who has money to buy?
Today in the Wall Street Journal we read about how “Big Currency Bets Backfired” leading to huge losses. Huge. It is well worth subscribing to the journal on line just to read this article. In a lengthy piece they attempt to explain why all this is happening. In short it is all part of this massive deleveraging and flight to safety process that is happening. US dollars that have made thier way abroad are now being pulled back home which involves selling out of that local currency and buying US dollars. In addition you have parties abroad (particularly corporations) that have either sold US dollars in anticipation of receiving them, which is now not happening as a result of the slow down, or they outright shorted dollars in favor of other currencies and are being forced to cover. Another reason is that in many countries interest rates are a lot higher and it is now expected that they will be cutting their rates which translates, all else being equal, to a lower value of that currency. ( an old concept I remember from school called interest rate parity and an unwind of the carry trade in which you park money in bonds denominated in currencies that have higher interest rates) Despite the massive injections of liquidity in to the market the world is short dollars. More importantly the world of US dollars is one of the haves and have nots. Certain countries have swap lines with the US Federal Reserves, and others do not.

For those who continue to want US Treasuries you are going to get lots of them in the coming year. The US is going to be borrowing a massive amount of money next year. Massive. This is a subject of another piece but one of the main things that keeps me awake at night. Who is going to buy all the US treasury bonds that we have to sell and at what rate?

A quick note in general on emerging markets – my hedge fund friends are telling me that we are going to continue to see a flight out of both equities and bonds possibly to levels we have not seen for years. Deflation is the word of the day and it is a pretty scary word.
A couple of other great articles worth reading – in the FT “The world wakes from the wish-dream of decoupling” and “Pakistan needs IMF help badly”.

A further note on GOLD – it broke through $740 an oz level today, in part because of the strength of the US Dollar. Gold is no longer todays trade but I still believe it belongs in a portfolio as insurance. There is a scenerio where the world goes back to some kind of gold standard. I cannot imagine, imagine, the impact of these dramatic swings in currencies. A strong US dollar is not necessarily a good thing as it chokes of exports big time. Exports have been a positive for the US economy this past while.

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