Carrying the dollar lower

September 14, 2009

There’s been lots of hand wringing over the fate of the dollar, with its recent slide giving rise to, in the words of blogger Macroman, the “dollar going down forever” crowd. Data released from the U.S. Treasury on foreign capital flows didn’t help matters. Seems in July foreign investors wanted to put their funds elsewhere.

Lots of ink has already been spilled on the well worn arguments that blame reckless borrowing by the US government and the growing movement toward establishing an alternative world currency as the drivers behind the dollar’s decline.

The latest theory gaining traction is the dollar is becoming the funding currency of choice. It’s a compelling case that the FT lays out nicely. It also fits snuggly into the “US. is becoming Japan” school of thought.

Analysts say negligible US interest rates, its quantitative easing measures and little sign that the country is set to withdraw from its ultra-loose monetary policy anytime soon leaves it in a similar position to Japan at the start of the decade.

“This puts the dollar in exactly the same position as the yen back in 2001 and makes it naturally attractive as a carry trade funding currency,” says Simon Derrick at Bank of New York Mellon. “The dollar is the new yen.”

The carry trade strategy, in which low-yielding currencies are sold to finance the purchase of riskier, higher-yielding assets, was widely used in the years prior to the eruption of the financial crisis.

But then again, it’s nearly impossible to prove how much this is driving the currency.

“It’s notoriously hard to find real data to determine the size of carry trades funded out of any currency, let alone the dollar. Hence, it has to remain the subject of conjecture,” he says. “Nonetheless, we feel that it is advisable to assume that this funding switch is happening.”

Macroman throws in his 2 cents here, and notes that the recent declines most likely have to do with foreign central banks cutting back on their dollar stocks that they built up over the last year. (China and Japan, however, added big to their US asset stock pile in July).

But then again, when everyone is comparing every asset class to pre-Lehman Brothers levels, why not lump in the dollar.

Here’s a chart showing the round trip.

dollarchart1

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