Mercury Rising 鳯女

Politics, life, and other things that matter

Is a dollar crash imminent?

Posted by Charles II on August 7, 2007

Via Brad Setser, the IMF says:

According to staff analysis by the Consultative Group on Exchange Rates (CGER), further real effective dollar depreciation of 10–30 percent would be required to eliminate the misalignment relative to medium-term macroeconomic fundamentals. Even taking account of capital market fundamentals, in particular the attractiveness of U.S. financial assets, inflows will likely diminish over time as portfolio demand is satisfied, implying a lower long-term value for the dollar.

I would guess that most of that depreciation is against Asian currencies rather than the Euro, meaning that the dollar could drop 60% against the yen and the yuan, but stay about the same against the Euro. But what path will this correction take? A slow, balanced, gradual decline, or a series of spikes? That’s the kind of thing that is beyond prediction.

The sometimes accurate Torygraph, through the pen of the even less often accurate Ambrose Evans-Pritchard of Whitewater fame, however, tells us that China may feel that this is a propitious time to use their currency as a negotiating point:

The Chinese government has begun a concerted campaign of economic threats against the United States, hinting that it may liquidate its vast holding of US treasuries if Washington imposes trade sanctions to force a yuan revaluation.

Two officials at leading Communist Party bodies have given interviews in recent days warning – for the first time – that Beijing may use its $1.33 trillion (£658bn) of foreign reserves as a political weapon to counter pressure from the US Congress. Shifts in Chinese policy are often announced through key think tanks and academies. (via cam at Setser’s website)

Now, as I say, Evans-Pritchard and the Torygraph are not to be taken seriously. But since financial people are much more likely to believe what they write than other people, this kind of thing is likely to add further angst to the markets. That nervousness could indeed bring on a dollar crash.

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