Why the US dollar is rising … when it shouldn’t be
A lot of people have seen their purchasing power disappear overnight because their currency has eroded very drastically over the last few weeks. In Canada, the loonie was trading at about par with the US dollar about 2 months ago and now it’s down around the $0.75-$0.78 range.
A lot of people have been scratching their heads trying to figure out why.
And along comes this site which offers a very sound rationale : there’s a massive debt being called in the derivatives market in the coming weeks and the only way to pay those debts is in US dollars, given that a broad range of commodities are still priced in US currency.
Expect more volatility as contracts wind down or are forced to be wound down. The time-frame will likely be 3-6 months and the gyrations in the market place will be in the range of several hundreds points per day as cash is generated and dumped into the market by automated trading.
And when the dust settles: "A new dawn will have arrived and what remains of the old world will have to be transformed to fit the new realities. Basically there is not enough cash on the planet to pay the Piper on this one."
The more I read about this, the less I understand. I read the article at Hubris & Nemesis you've linked. They list the derivative/swap market at close to $600-trillion. That's a staggering amount of debt. Just out of curiousity I went looking for the total value of the American housing market. In 2006 it was just over $20-trillion. How in hell can assets worth twenty trillion dollars be parlayed into securitized debt of close to six hundred trillion dollars? Given that America's total GDP is $14-trillion, there's no government, no group of governments that can stand up to debt of that magnitude. There needs to be a massive devaluation of those securities by the world's governments. There was no value in them to begin with (beyond $20-trillion max and that's wildly overstated) so why should governments use tax dollars to breathe wealth into them now. That's handing these guys a total windfall.
Phew!! I'm not an expert, but I'll take a quick stab at addressing your question.
Generally, it's all about leverage. The Glass-Steagall Act was introduced in 1933 and established the FDIC in the US. It included many banking reforms, most of which were designed to curb speculation. When the Glass-Steagall act was repealed (under the Clinton admin), companies subsequently were able to leverage any assets (including those based on volatile debt structures), some to the tune of a 30-to-1 ratio. Therefore, for every dollar of 'value', $30 in derivatives and other security debt were generated.
Now, your astonishment is quite reasonable, given that most 'experts' are ignoring this phenomenon and seem content to continue plugging the leaky dam with their fingers while tsunami waves of other debt and derivative issues flood around them. The challenge for everyone is understanding which of these $600 Trillion in assets are real versus created from leverage or the extent to which they'd 'disappear' in the event of another larger derivatives meltdown.
What's most important to me is trying to understand why the US dollar is rising when it really shouldn't be (I mean, why would you invest in a turkey?) and this piece helped a lot by pointing to the mark-to-mark clearing that occurs for nearly all derivatives that are cleared in US funds. That means people will demand real dollars in order to liquidate (or maybe buy) more derivatives as they wind down their positions. I know it may not offer a perfect description of the impact of derivatives on our market and the financial crisis, but it helps me understand why commodities (again, all priced in US funds) are crashing because as the dollar goes up, everything else will go down.
It's a bit of a perversion and anyone should expect a pretty severe pendulum-like swing as the demand for the US dollar recedes and people look for other markets in which to invest what's left of their cash.
PS: Please note that any of these posts do not represent financial advice by any count. You should always consult a professional advisor before making any financial or investment decisions.