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The biggest riddle in today's financial markets is definitely the US dollar. Economists, traders and even the average layman are trying desperately to understand where the greenback is going.
The puzzle that disturbs all these minds is rather simple: For the past 12 months the printing press at the US Mint has been working harder than ever. The amount of new money that was poured into the markets, through new notes, loans and massive intervention in the bonds and securities markets is amazing: almost $5 trillion since last July, and about $9 trillion more in future guarantees.
But for all of the Federal Reserve's largesse, the dollar is stronger now than it was a year ago. In July 2008 it reached a low of almost 1.6 against the euro; now, even after four straight months of decline, the dollar is traded at about 1.4 per euro. If we bear in mind that the interest on the euro is much higher than that on the US currency, and that the European Union's various stimulus schemes are nowhere near the size of the American ones, the confusion only gets worse.
Of course, there is some logic behind this wild money printing. Not only is it an immediate remedy to the sudden shortage of liquidity that was created when the credit bubble exploded, a shortage so severe it threatened to destroy most of the banks in the US, it was also considered by some policy-makers as a great solution to America's most serious problem: the staggering deficit of the world's largest economy.
The US deficit has already reached a record $12 trillion, and that's only the beginning. Ambitious government health care plans together with an aging population that threatens to collapse the social security system will probably force the Washington to increase this debt burden significantly. By printing dollars like crazy, the Fed hopes to erode the value of this enormous debt. Indeed, this is a prerogative given to the world's most powerful nation, whose national currency is the world's standard.
The weak buck is also giving American exporters a good head start when competing with their European and Japanese peers.
But it is exactly this debt-eroding scheme which frightens America's largest creditors. No wonder that China, the US's biggest foreign lender, is leading the call for establishing a new international base currency. Other countries that run a current surplus in their trade with the US are joining this call, and devious politicians in the EU are sensing a chance to regain power and prestige through their new and successful currency.
So how is it that the dollar has been able, so far, to maintain its buoyancy?
The most common answer is that foreign exchange markets take under consideration many more factors than just the base rates of a currency or the printing rate of a certain central bank. Many analysts argue that an even more important factor is the strength of economies.
These experts believe that the many stimulus plans, which are the reason for the huge increase on the monetary base, are doing the job: The free fall in the financial and real markets has stopped and there is hope for a recovery in the US markets in the near future. Also, the panic in the world's financial markets that reached its peak last September when Lehman Brothers, AIG and Merrill Lynch collapsed, ignited a wave of investors running to safety. Money began to flow to the only place that investors worldwide considered secure: the US government bond market, denominated in dollars, of course, thereby raising the value of this haven currency.
But even if we accept this theory, the future of the dollar seems very gloomy. Let's say that the US economy will eventually be the first to emerge from the current havoc. The burden of its huge debt will still be there. In the long run there is no other choice for the US government but to significantly raise taxes, and that will surely dampen growth rates in comparison to other developed markets. A renewed world growth will also renew investors' appetites for risk, so we can expect a reverse flow of capital from safe low-yield investment like US treasury notes to high-yield foreign markets.
The bottom line is that the most likely scenario is a decline in the greenback's value against other currencies: whether it's the euro, "commodity currencies" like Australian and Canadian dollars, or emerging markets currencies like the Chinese yuan. This is true even if we optimistically expect a recovery in the US and global markets in the near future, and especially in the catastrophic scenario of a further collapse and a failure of the giant stimulus plans. In that kind of scenario it is very likely that the run for safety will not be to US bonds or other solid dollar-denominated assets but to gold and other hard and traditional assets like gemstones or even agro commodities.
Here in Israel the future of the shekel seems bullish. Until now, the only thing that has held down the dollar in the local forex market has been the intervention of the Bank of Israel, which bought billions of dollars over the past few months to support the depressed export sector. The bank cannot continue this activity forever, and all other fundamentals - trade surplus and capital inflows - are in favor of the shekel. It is true, though, that in the worst case scenario of a global collapse, chances are we will see a flight to the dollar, mainly by foreign investors who will probably run in herds away from emerging markets. So, the future of the Israeli foreign exchange market is not as clear as that of the dollar.