Sunday, September 13, 2009
Liam Halligan writes in the Telegraph of the grave danger posed by a world awash in cheap (and getting cheaper by the day) U.S. dollars, a condition that doesn't look as though it will change anytime soon given the likelihood of U.S. interest rates staying low for quite a while.
The dollar is now being used as a "carry" currency. Traders are using low Fed rates to take out cheap dollar loans, then converting the money into currencies generating higher yields.Hmmm... A snap back in the dollar that causes a financial crisis that, in turn, spurs more dollar buying in a flight to safety and an even stronger dollar - that does sound dangerous.
"Carrying" credit in this way is currently the source of huge gains. No one knows the true scale, but the world has, of course, been flooded with cheap dollars.
This presents serious systemic danger. A dollar weighed down by Chinese divestment, then suppressed further by carry-trading, could easily spring back. Those who had borrowed in dollars would owe more, while their dollar-funded investments would be worth less. This "unwinding" could send financial shock around the globe.
This is what happened in 1998, when yen carry-trades went wrong, causing the collapse of Long-Term Capital Management and sparking a global slowdown.
So even if the Western world manages to fix its banking system, the Fed's money printing could well be stoking up the next financial crisis. The dollar carry-trade. You heard it here first.