Revenge of the U.S.$

Raaphy Persitz
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Raaphy Persitz

The world capital markets turn over about $2.5 trillion in a single trading day (of which Israel is responsible for the thousandth part). A bit of that turnover represents import and export of material goods and services (such as tourism), or material trade in stocks, bonds, properties, and the like.

Some of that turnover derives from futures transactions and some from swaps, which involve buying one currency for immediate delivery in exchange for another in the spot market, while simultaneously selling (at a rate set in advance) the acquired currency in exchange for a currency to be sold in the future. The difference between the immediate and the future rate derive from the difference in interest rates on the two currencies.

A speculative bonanza

Some of the vast $2.5 trillion turnover represents hedging of exposure. Some is from a flourishing business in speculation, by gamblers and day traders who exploit the generous leverage (100:1) they are granted by market makers (a permission to set up a giant exposure based on a tiny deposit). Their aim is to magnify short-term fluctuations to make fast profit.

A great part of the daily turnover consists of nothing more than offset transactions, designed to balance surplus currency positions that market makers accrued during the day of trade.

The charts below track the fluctuation of the U.S. dollar versus other currencies (including the basket) during 2005. They show that throughout the year, the dollar overcame the rest, with the exception of the Canadian dollar, by various degrees, defying investors such as Warren Buffett and speculators who had expected a black year for the greenback.

What will the dollar do in 2006?
Top left: Weighted dollar index; Top right: Euro-USD
Second row, left: Swiss franc-USD; Second row, right: GBP ?USD
Yen-USD; Rand-USD
Canadian dollar-USD; Australian dollar-USD
New Zealand dollar-USD; Shekel-USD

Dollar detractors in early 2005 relied on the supply side, which threatened the greenback's status. That refers to the U.S.'s tremendous trade deficits and budget deficits, which have mushroomed to a trillion dollars a year (while American military action in Afghanistan and Iraq has hugely increased the budget deficit).

What ruined their gloomy forecasts was that they ignored the signs of demand for the dollar.

Flood of foreign capital

• They ignored the flood of foreign capital to American shores; petrodollars from OREC countries and more from exporters such as Japan, China and others. That flood more than offset the deficits.

• They overlooked the fact that the American economy continued to flourish in terms of GDP growth, employment, productivity, and more, compared with the European economies, Japan and others. That prosperity attracted foreign investors.

• From June 2004 the Fed raised U.S. interest rates from 1% to 4.25%. Risk-free deposits and savings denominated in dollars, treasuries and the like, returned more than similar instruments denominated in euros, Swiss francs, etc.

• They forgot that however strong or weak it may be at a specific point in time, however cheap or costly, in the absence of a liquid alternative, the U.S. dollar has no competition: it is the global currency. For better or worse, even if all the world investors were to suddenly decide to move their investments to something else, they couldn't! All the financial centers in the world couldn't handle capital movements of such magnitude.

Yet these considerations have not stopped the Cassandras of 2005 from predicting another lean year for the dollar in 2006. Will they face another public humiliation?

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