Author: Dan Keeler


It is not difficult to be bearish on the prospects for the US economy these days. By late May, consumer confidence was tailing off, and there were clear signs that the housing market—long employed as a virtual cash machine by US homeowners—was softening considerably. Continuing inflation concerns, fueled in part by high energy prices, were prompting Fed chairman Ben Bernanke to consider further interest rate hikes. With the relentless growth in the US trade imbalance showing no sign of abating, the dollar shrugged off the potentially beneficial effects of rising interest rates and continued its leisurely slide against most other major currencies.

While most agree that the dollar falling further is not only a good thing but is inevitable, just about the only people who want their own currency to rise against the dollar are tourists planning a trip to the US. There can be few governments who view the prospect of their country’s currency rising strongly against the dollar with anything but alarm.

Nowhere is this more apparent than in Asia, where many countries have been buying dollars at such a rate that their combined foreign exchange reserves reach into the trillions. It’s been a very effective strategy for most and has helped keep their own currencies at relatively low valuations—and thereby prop up the dollar. In the process, though, China and other Asian nations have painted themselves into a very tight corner. They are so heavily invested in the dollar that any decline will cost them dearly. They know, however, that a decline is almost inevitable, and the longer they hold onto their vast dollar reserves, the more any slump in the greenback will hurt.

Those nations have essentially placed a gigantic bet on the global currency markets. Their bet is effectively that a sharp decline in the dollar would be so disastrous and chaotic that the world’s monetary authorities would step in to prevent it happening. Looked at from another perspective, though, they are acting like investors who continue to throw good money after bad in the hope that their initial conviction will turn out to be correct. They have been trying to call the market’s bluff, feverishly buying something that was already overvalued in the hope that their buying pressure would help sustain the value of their investment.

The problem is that buying pressure alone will not be enough to prevent the dollar slumping further. And, unlike the gambler on a losing streak at the poker table, their problems can’t be solved by turning up a lucky card.

Until next month, Dan Keeler