Dollar as Safe Haven

Brad Setser notices that, this time, bad news for the world economy wasn't good news for the dollar:

Brad Setser: One interesting point: the dollar didn’t benefit from today’s flight to quality. Fair enough. The currencies of countries with big current account deficits facing a shortfall in private inflows aren’t classically considered the gold-standard by those looking for a safety.

That though is a bit different than last spring, when the dollar did benefit for a while from the flight out of emerging markets in May (more here).

I think Macro man probably has this story right: after the April 2006 G-7 communique (the one that briefly made Dr. Roach an optimist) some big players started to bet that the dollar would fall... using the dollar to finance their high-carry bets on Turkey and Brazil... [or] on Turkish, Brazilian and Russian equities. When those bets unwound in May and June, the dollar got a bit of a boost.

Today, though, it was the yen that got the big boost. Bloomberg:

The yen also advanced 4.1 percent against the Turkish lira, 3.9 percent versus the South African rand and 2.8 percent against Iceland's krona as investors shunned riskier assets in emerging markets following a rout in Chinese stock market shares.

Yet more circumstantial evidence that leveraged bets on the emerging world right now are--or were--financed not with dollars but with yen and swiss franc...

Comments

[anne]

What we do not understand, and what I worry about, are connections that derivative use have created among investment markets that are not easily untangled. Berkshire Hathaway spent several years to shed a derivative portfolio, a difficult expensive process in an excellent market.

[kharris]

The point about the currency used to finance those trades is exactly right. The dollar had been the beneficiary of leverage, rather than its source. It is thus mostly a mechanical response, the result of reducing risk by reducing leverage, that led to the dollar's drop. There may be very little in the way of judgement about US economic prospects in the sale of dollars Tuesday.

If you look at what happened to Treasuries vs stocks, you see strong evidence of a flight to quality within US markets. Twos went crazy and stocks got killed. That is a very standard response. More and more evidence that Tuesday was an episode of shedding risk.

By unhappy coincidence, we had some weak economic news on the same day, just to complicate the analysis, but we also had some strong data that day. Starts to look like data mining to blame durables and ignore home sales.

[knzn]

It makes a big difference which emerging markets are involved. In the case of China, their currency is effectively tied to the dollar, so for the dollar to rally, RMB would also have to rally. A stock market crash is usually a negative for the currency of the country in which the crash occurred, and by extension it should be considered a negative for any country with which that country maintains an exchange rate that is nearly fixed in the short run.

[Ian Whitchurch]

Shanghai sneezed, and Wall Street caught a cold.

Welcome to the brave new world.

Ian Whitchurch

[kharris]

Ian and KZNZ both show up on the same day. This is a good omen.

[anne]

The question from here is on derivative connections. Reducing risk is simple beyond the severe stickiness that derivatives can bring, and I have no idea whether prime investment houses are holding derivatives that are especially sticky in a weakened market. Where is the bad mortgage debt, and does it matter? Has Morgan Stanley rid itself of risky mortgage debt, and if so how?

[Ian Whitchurch]

Oh yeah, and on a related matter ... I think the evidence is in.

Ghawar's fucked.

www.theoildrum.com has some drop-kicks and annoying posters, and I'm still not convinced that Hubbard Linearisation predicts future oil finds, but Stuart Saniford completely and totally nails the Saudis.

They brought Haditha on line at 300 kbpd, and they still had a fall from 9.4 or so, to 8.7 or so.

Ghawar's water cut must have taken a jump, and Cantarell and Burgan have shown what happens when that happens if you are using modern horizontals.

Ian Whitchurch

[Scorpio]

This is not a great surprise. The last president who devalued the dollar was Nixon.

Bush has just -- degraded our ability to claw out of debt. Moreover, the economic policies of late have made our own productive output a lot weaker.

[Michael Sullivan]

A former options trader whose livejournal I read (Johnathan Kaplan) had an interesting take on the recent financial market hullabaloo. That a large part of the movement going on right now is due to expectation that the Bank of Japan will turn off the free money tap (raise interest rates above zero) in the near future.

Basically a lot of big investors have been borrowing yen to finance investments around the globe and now they are getting ancy about their position.

The big yen spike is a good indication that he's on the money about this.