Tuesday, May 22, 2007

Conspiracy to support the dollar

This exchange of letters in the Market Oracle has very significant implications. It's a discussion of the huge international "carry trade", which means borrowing in one country at low rates of interest, to invest in another country.

In this case, it is loans from Japan to invest in US Treasury bonds. The columnist, Professor Antal E. Fekete, says that Japan will keep its interest rate low, because otherwise the yen would rise, hitting Japanese exports. On the other side, the US Treasury will maintain or even increase interest rates on its bonds, to prevent the dollar from collapsing, despite America's economic weakness. China has no wish to destabilise the dollar, and as the Professor points out, some of China's enormous gains from the US come from its holding of Treasury bonds. So there are powerful vested interests sustaining the status quo.

This is a cool-headed contrary view to that of the most pessimistic bears, who feel in almost a moral sense that the present state of affairs ought to end in tears. It is the very awfulness of the potential consequences of a sudden, radical change of balance in the world economy that motivates the main players to keep the polite fiction of normality going.

So the Professor is a "bond bull": yes, the dollar may gradually decline; no, it will not suddenly dive. That's his position.

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