Market Direction

The End of the Dollar Bubble

The reaction of traders to Friday’s Non Farm Payrolls may be the most concrete sign that the currency markets are coming to the end of the financial crisis. The initial response was, as it has been since the unwinding of the security dollar bubble began in March, to sell the dollar against the euro. But the dollar sellers exhausted themselves after barely five minutes and the following dollar surge, though also five minutes, covered twice a much ground. From 8:30 am to 8:35 am euro rose 34 points, from 8:35 am to 8:40 am it dropped 76; good American economic news had finally garnered a positive response from the currency markets.



From last September until March the dominant currency trade was a direct kin to the panic in the financial markets. When in doubt, which was a constant, purchase dollar denominated assets. A huge bubble of Treasury assets were bought with foreign and domestic money. As the crisis rolled on, even though it had started in the US, involved many of the most prominent United States financial institutions, and called forth an unprecedented amount of government intervention and a deluge of dollar liquidity, nothing dented the dollar’s ascendancy. Compared with the potential for the rest of the world the United States was the safest holder of wealth.

The strength of the dollar in this period owed nothing to the traditional standards of economic and currency comparison. Though the amassing of the world’s financial liquidity in United States Treasuries would not typically be thought of as an asset bubble, by any measure of the origin and behavior of asset bubbles it was. Treasury prices were driven higher by unceasing demand which for a time ignored cost and return in a desperate race to secure principal. The psychology of fear is not very different from that of greed in its ability to push markets to excess. Bubbles can form for negative as well as positive reasons.

The dollar asset bubble began to unwind with the bottom of the equity markets in March. If the September to March dollar was the security dollar then we can call the March to June dollar the repatriating dollar.

As financial conditions gradually improved, investors sold Treasuries and placed their funds in commodities, worldwide equities, currencies and other instruments looking for appreciation and return. Because the process did not unfold at once, and because it was largely better conditions in the United States that emboldened investors to assume more risk, it seemed that whenever there were improving economic statistics in the US the dollar would sell off. In fact this was the necessary dollar selling that accompanied the repatriation of foreign-owned dollar assets or American dollar assets transferring to overseas markets and investments. .

Neither the rationale for the security dollar nor the logic for the repatriating dollar could last beyond the original financial and market conditions that produced them. Owners of investment funds will not accept minuscule earnings forever. And despite appearances the amount of funds stashed in Treasuries is not infinite. When the repatriation is complete the pressure on the dollar engendered but not caused by a mending US economy will be removed. We may have finally reached that point.

This does not necessarily mean that the dollar is poised for a strong recovery. The US economy has very serious current and pending problems and the path away from the financial crisis to recovery is unknown; but then again that applies to the rest of the world as well.

The Eurozone and Japan are trailing even the small signs of stability that have arrived in the United States. Still, if the historical performance of the US economy is considered along with the enormous fiscal and monetary stimulus that has been applied to the American economy, the dollar could well outstrip its competitors without the revival of normal economic growth anywhere in the world.

Joseph Trevisani

Market Direction

The rise of the Australian and New Zealand Dollars from their March depths to their current levels has been an Asian success story.

Chinese economic growth has cushioned the effects of the worldwide recession in New Zealand and Australia. Both countries export large amounts of raw materials to Asian manufacturing centers, China foremost. The yuan is fixed to the dollar (unofficially) the aussie and kiwi are not. The Australian economy has avoided recession; the New Zealand economy shrank just 1.0% for two successive quarters. As China returns to strong economic growth and the potential for internal unrest diminishes, the two Asian Dollars rise, and everyone in Asia benefits.

China has boosted her GDP growth from 6.1% in the first quarter of 2009 to 7.9% in the second. Beijing’s four trillion yuan ($587 billion) stimulus has produced tangible results. The Shanghai stock exchange is booming, bank loans and credit are flowing to business and consumers, property markets are hot again, and car sales have overtaken those of the United States. The Chinese government, spending money it actually has, is courted by Washington’s debtor politicians who proclaim their belief in a strong dollar and fiscal rectitude lest China Chinese officials withdraw their support for US deficits. The strength of the Chinese economy is imparted to her trading partners and material suppliers Australia and New Zealand, and their currencies rise against the dollar and the moribund American economy.

The additional success of these two commodity currencies is owed largely to the dynamism of the Chinese economy. Without the demand from the mainland, the miners and ranchers of down under would have few places to sell their products. Though the fall in the Antipodean currencies last year had everything to do with the American dollar, the climb back has been, to a large degree, an Asian affair.

From last summer until this past March the Australian and New Zealand currencies had suffered the same precipitous decline against the dollar as did every major currency except the yen. Panic buying of American Dollar assets trumped every financial and economic consideration during the prolonged financial turmoil. For the six months following the collapse of Lehman in September neither the aussie nor the kiwi sustained any appreciable rally.

However, since the recovery in world financial markets that began in March these two currencies have gained more than twice as much against the dollar as the euro. From March 4th to June 3rd the euro improved 14.3% against the US Dollar. In that same period the Australian Dollar gained 31.4% and the New Zealand Dollar 34.1%.

Traders, portfolio managers, investors, fund managers, almost everyone who had sought safety in the States and Treasury investments began in the second quarter to seek higher returns outside the United States and largely outside the industrialized world. A portion of the improvement in all currencies versus the dollar was due to this repositioning of assets to more favorable economic environments.

The most favorable of all the destinations, by performance, fiscal ability and government intention was China. Of the major trading currencies the Australian and New Zealand economies have the closest economic connection to China. If China grows by exports or domestic consumption the benefit to the Australian and New Zealand economies are direct, substantial and evidenced in the comparative performance of the two economies.

Japan also has large interests in the China. But the Japanese economy is a special case due to its dependence on exports and limited domestic consumer consumption. The yen also has unusual contingencies that give it undue resilience, primarily its decade long participation in the carry trade and its collapse last fall. Nevertheless one of the reasons for the continued yen strength is its Chinese relationship.

The Chinese stimulus was announced in November of last year but its success was not apparent until the recent release of the second quarter GDP numbers. But the advantage to the Australian and New Zealand Dollars was already priced in by the beginning of June.

Further improvement in the currencies will hinge on continued Chinese expansion. The quality of the economic growth in China is open to speculation. Some of the markets, particularly equities and housing, have bubble like aspects to their rise. Bank loans and credit expansion have been overwrought. Mere concern that the government might tighten credit was enough to cause a five percent fall in the Shanghai exchange.

If the Chinese economic recovery is solid, if it is not grounded in misplaced credit generation and speculation, then the aussie and kiwi have a stronger immediate future than any other major currencies. If China cannot sustain her current growth then these commodity currencies will quickly fall to earth. Either way the Australian and New Zealand economic futures will be written in Beijing and not Canberra or Wellington.






Joseph Trevisani