Something fishy with the US Dollar

This is the NYBOT index, showing the value of the US Dollar against the currencies of its major trading partners. As you can see, the US Dollar has been in decline since around November 2006, reaching the bottom in around April-May this year, and then zooming up suddenly in August 2008.

I gotta say, this is fishy.

It's fishy because much of the decline in the US Dollar occurred during the credit crisis. The crisis, which started in August 2007, has continued now for over twelve months. Nothing has improved. Unemployment has gotten worse, the housing market has continued to tank, GDP is declining - in short, there are no economic indicators that suggest the US economy is getting better.

This is all the more stranger when you realise that interest rates in the US are now as low as they have been in recent history. Whoever it is buying US Dollars at the moment is not going to benefit from interest repayments, which are more attractive in places like Europe. The only way international investors are going to make money out of this recent spike in the value of the US Dollar is if they are betting US interest rates are going to increase, or if they expect the value to keep rising. The latter explanation is, I believe, what is probably going on... and that means speculation and a US Dollar bubble.

Of importance to this scenario is the fact that the world commodities market has finally popped. Gold, iron, silver, coal and oil have all dropped in value. The reason is obvious - people who have been speculating on the commodities market have begun selling their interests there and using the money to buy US bonds.

In many ways the progression here is important. There was a tech boom in the late 1990s so investors created an investment bubble in the US stock markets. Once that popped, they took their money out and invested it in housing. After that popped, they invested in commodities. Now that that has popped they are investing it in US Dollars. The fact that this has resulted in a rising US Dollar has led to a virtuous cycle, making the Dollar more valuable and commodities cheaper.

Another factor here is the role of central banks. I have been reading around econ blogs and many are of the opinion that the recent rise in the value of the US Dollar has a lot to do with behind-the-door negotiations between the Federal Reserve and other central banks (European Central Bank, Bank of Japan, China, etc). A rising US Dollar would help lower inflation and help stimulate an economy geared towards consumption and borrowing. It would also help economic conditions prior to an election.

One thing, however, is certain - the US Dollar cannot sustain its current value. The US has a large and unsustainable current account deficit that must be reversed if the economy is to rebalance itself.

If I may indulge in a bit of sinister conspiracy - I'm wondering if the current rise is also due to a foreign central bank whose actions in buying up US Dollars has attracted the international forex market back to it. Once the value of the US Dollar has reached a certain point, the central bank will sell off and make a profit, resulting in a sudden drop in the US Dollar - a process that will make things even more confused and dangerous than it already is.

After all, the writing is on the wall for international investors: the US economy is in the doldrums and is no longer a safe place to invest.

I predict that within in the next three months there will be a sustained drop in the value of the US Dollar.