What will happen with the dollar?

by on October 2, 2008 at 6:24 am in Economics | Permalink

Keith asks, as do others:

I had been curious as to how this whole situation will effect the dollar…If you find the time, I would like to know or see the future of the dollar in this situation.

Please note that I am a "buy and hold" guy, not a trader, and I am certainly not a currency trader.  But I’ll cover the dollar vs. the Euro.

My inclination is to think the dollar will hold its value.  I don’t trust any of the macro models of currency values and we do know that purchasing power parity, while very approximate, and exerting its force only in the long run, does not imply a bearish stance toward the dollar.

Here is a list of European banks with assets greater than the gdp of their respective home countries.  And read this.

As for this country, the Chinese now regard us as "battle tested."  We have been through some truly major bumps, yet no major U.S. politician has called for "not paying back the Chinese."  We’ve even guaranteed the $350 billion in agency securities held by the Chinese central bank and without a stir.  I think the Chinese are shocked by that and in many ways they now trust their investments more than before, not less.

The Chinese do not have comparable trust in "Europe."  If something went wrong in the financial realm, who would they call up on the phone?  Which country?  What do they think is the power base of the head of the ECB?  What political party does that person belong to?  What favors can be traded and with whom?  Whose answer would count as definitive?  Keep in mind that for all of China’s modernity, their leaders are still communist party functionaries.

The negative scenario for the dollar is where the Chinese economy collapses, not where the Chinese become too afraid to buy dollar-denominated assets.

Bush, Bernanke, Paulson — we call them leaders.  The Chinese think of them as the customer service department.  I suspect the Chinese get straighter answers from them than we ever do.

Cliff October 2, 2008 at 7:57 am

Hold on a second- now the Chinese are shocked that we’ve guaranteed their agency securities? I thought they were so sure of that, that if we had not done it, it would have resulted in the apocalypse? Anyone else remember that post?

Kyle S October 2, 2008 at 8:11 am

a new iPod nano 16gb costs over 50% more on amazon.de than it costs on amazon.com (225 EUR vs 189 USD). just saying…

y81 October 2, 2008 at 8:31 am

Go back to that list of European banks. Isn’t that a little frightening? If one of those banks fails, won’t it drag down some governments? (Especially given that European governments do not borrow in their own currency.)

eccdogg October 2, 2008 at 8:55 am

Cliff both statements can be true.

The Chinese could have believed say that there was a 90% chance that they would be paid back in a crisis.

Once the crisis happened and they were paid back now they are nearly 100% confident they will be paid back.

So they were very confident before but are more confident now.

David R. Henderson October 2, 2008 at 9:21 am

Tyler,
You wrote, “Bush, Bernanke, Paulson — we call them leaders.” What do you mean, “we?” They’re not leading me.
David

Gabe October 2, 2008 at 9:28 am

“We have been through some truly major bumps, yet no major U.S. politician has called for “not paying back the Chinese.”

Your wrong, check the fed website. Bernanke gave a big speech on this where he said we have a technology called the printing press and we can use it if we need to in order to escape huge debts.

rubashov October 2, 2008 at 9:44 am

I’m curious where the opinions in the original quote came from. Are there interviews with Chinese leaders out there? Other people’s research? I’d like to believe all this is true, but I’d sure like to see some supporting evidence. Tyler?

Bob Murphy October 2, 2008 at 9:50 am

My inclination is to think the dollar will hold its value. I don’t trust any of the macro models of currency values and we do know that purchasing power parity, while very approximate, and exerting its force only in the long run, does not imply a bearish stance toward the dollar.

As usual, my inclination is to think that this post will not hold its value. :)

I agree with Tyler that the Treasury will do whatever it can to placate its bankers, i.e. the Chinese. But I don’t see how purchasing power parity (PPP) has much to do with the reader’s question.

If housing prices continue to plummet, and the Fed / Treasury continue with their generous assistance programs, at some point they are going to start printing new dollars like crazy. Then US prices skyrocket, and PPP says the dollar falls in the foreign exchanges. Right?

To paraphrase my point, it seems as if Tyler above is saying, “Remember folks that currency traders eliminate arbitrage opportunities. So the dollar shouldn’t fall in the long-run against the euro.”

P.S. I consider David Henderson my leader.

Melpomene October 2, 2008 at 10:00 am

This post sounds pretty vindictive, Tyler. Almost as if you want Europe to tank as well (or even worse) so the US problems won’t hurt as bad by comparison. Shared misery is halved misery?

Gabe October 2, 2008 at 10:38 am

“agree with Tyler that the Treasury will do whatever it can to placate its bankers, i.e. the Chinese.”

Anything accept withdraw troops from Japan, South Korea etc. This is because while we can safely borrow trillions from China, we must simultaneuosly invest trillions in national defens and hundreds of bases aroudn the world to keep us safe from the communist armies that will surely invade our country should we take our troops out of Korea. This is the reason we must increase taxes in the future, to keep us free.

Zamfir October 2, 2008 at 11:10 am

I do not understand why Tyler keeps showing the graph with European banks that are larger than their home countries GDP, as if that means that a bank is too large to rescue. The number 6 or so on that list, Fortis with assets 2.5 times the GDP of Belgium, has actually been partly nationalized only 2 days ago.

The Belgian, Dutch and Luxembourg each paid a few billion, the Netherlands and Luxembourg now own 49% of their national part of the bank, the Belgian government owns 49% of the rest. This transaction apparently went smooth, without much political plays between the countries. I guess similar transactions would be possible for other banks that operate largely in other countries.

Anonymous October 2, 2008 at 11:25 am


One cannot post anything that can be remotely construed as positive (well, really, one cannot post anything thoughtful) without being smacked by the gloomspeakers.

In the spirit of “just because you’re paranoid doesn’t mean they aren’t out to get you”… well, just because the usual suspects are gleefully hoping to dance on the grave of the Bush administration, America, capitalism, globalism, free trade and the world as we know it, doesn’t mean that we aren’t, uh… how do I put this? Cockney rhyming slang: “fully plucked”.

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Shakes The Clown October 2, 2008 at 7:49 pm

“Bush, Bernanke, Paulson — we call them leaders. The Chinese think of them as the customer service department. I suspect the Chinese get straighter answers from them than we ever do.”

That is hilarious.

Thomas October 2, 2008 at 10:36 pm

Note than on your list of European banks, neither Iceland nor Switzerland (the first four) use the euro or are members of the EU. Iceland is clearly in trouble but Switzerland is so far one of the only countries with a major financial center that did not need any government interventions. How will to drastically deteriorating balance sheet of the US affect the dollar?

Torris187 October 3, 2008 at 12:12 am

I might be making this crisis more simple than it is but here is my take.
1. US households/ US government / Wall Street are all broke.
2. The US government is going to “borrow” over a trillion dollars from us through seignorage, which will cause us to operate at an unneficient point.
3. The US government then will lend that money to Wall Street banks at a reduce interest rate with a high risk (since nobody knows the asset value of these banks).
4. The Wall Street banks then will loan us that money back at a higher interest rate then the Fed loans them (r*>theta).
5. Wall street will make a temporary profit from these loans.
6. Households will be unable to repay these loans due to high inflation and declare bankruptcy.
7. Banks will then declare bankruptcy dues to the high foreclosure and default rates.
8. Were back to square 1.

boo October 3, 2008 at 2:15 pm

Regarding the link to the FT piece on European banks vs their local GDP. If we take ING, for example, we have a company that is one of the largest financial institutions in the world (top 20) and one of the largest by revenues (top 10). The population of the Netherlands is a little over 16 million, the number of customers of ING is 75 million. Of course their assets are going to be a multiple of Dutch GDP! It is a meaningless stat. What is meaningful, however, is that Europe (outside of the UK) still has savings that can be spent. As to the Chinese trusting the US more than Europe. I don’t know the real answer. However, there has never been any doubt that US paper being held by the Chinese would be repaid. Because, once that stops, it is game over. But, if I’m from China looking on I’m seeing European governments taking transparent equity stakes in their banks and the US govt intending to buy portfolios of CDO’s. I think know which option looks more trustworthy to me…

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