Part of the story behind today’s market decline was the continuing weakness of the dollar.  While this has not been a major theme here, it does illustrate an important point.

This is a subject that most people do not understand.  Many of the sources offering information have a strong political viewpoint.  It can be difficult to figure out where to get solid information.

Some Important Considerations

Here is a summary of conclusions that we have reached.  We would be willing to defend each, and might do so in future articles, but this piece is only a synopsis.  As usual, we are sticking to topics within our own expertise or helping to identify genuine experts.

• Markets are highly sensitized to dollar weakness and the flip side, commodity strength.  Interviews with those in the trading pits highlight a crowded trade.  There is plenty of reason for them to go with what is working.  Futures traders are trend traders.
• China is not on the verge of calling in all U.S. loans.  Many try to understand international economics through a gross oversimplification: thinking of countries as individuals or families.  In fact, Chinese leaders maintain a trade imbalance because it helps them grow their economy and employ workers.  It would not be in their self-interest to weaken their own industry or the value of their current dollar holdings.  Despite these facts, pundits have created a climate where many expect imminent disaster from this debt.
• The U.S. current accounts deficit also reflects the national interest of many countries who compete in exporting to the U.S.  Former Dallas Fed President Bob McTeer has an excellent non-technical explanation of this, well worth the time to read.
• If there were to be a change in Chinese policy, we will not learn of it through Cheng Siwei, the Vice Chairman of the Standing Committee of the National People’s Congress.  Given the lack of knowledge about China and the current climate of fear, any threatening remark gets plenty of attention.  Phil Izzo in the Wall Street Journal’s Economics Blog was quick to post a great roundup of economic commentary, but the market damage had already been done.  One great comparison ,from Carl Weinberg of High Frequency Economics, likened Cheng Siwei’s comment to a Charlie Rangel speech telling the Fed what to do with monetary policy.
• The Fed is not going to change interest rate policy in reaction to the dollar.  Once again, there is no source better than Bob McTeer, who gives the inside story on the Fed reasoning.  He made similar comments on tonight’s Kudlow and Company.

Conclusion and a Little Speculation

At some point (maybe now?) the dollar decline will no longer serve the various national interests.  When Robert Rubin was Treasury Secretary, he had a reputation for deft currency intervention, often at a time when it would  have the greatest impact.  It would not be surprising to see something like that, perhaps in concert with other nations.  The action would be accompanied by some tough talk.  Such a move, if timed correctly, would also have a positive influence on potential foreign investors in U.S. assets.

While a gradual decline in the dollar versus certain currencies may resolve some trade problems, the rapid decline of recent days does not serve any national interest.  In such circumstances, governments generally take action.

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