The wonderful inflation/deflation discussion in the previous post inspires me to continue the topic.
Something very important happened yesterday. The dollar made a very clear double-bottom, which will prevent any further decline for at least half a year, and half a year is a long time. Well, unless something extraordinary happens.
So why is that? We know that US is aggressively reducing interest rates while there is a lot of places in the world that do fight the inflation, so borrowing cheap and lending abroad should press the dollar down. I think that to move the currency it is insufficient to have the interest rate differential – you need to physically move money and open carry trade positions. And so far the banks show very little interest to do that. Yesterday banks borrowed only $6.7 bln at 2.6%, which resulted into $11 bln drain. Today they are borrowing only $5.5 bln at 2.3%, another drain. Can you imagine that the banks are refusing to borrow above 2.3%? It’s a strike, a real strike.
There was a question in the comments section – why banks are refusing to borrow while they have record low cash reserves? The answer is simple – those are different banks. Those banks who refuse to borrow above 2.3% do not lend money to those that run low at cash reserves.
So, can the Fed just inflate away from the problem? Reading the comments section it seems that the Fed has no legal mechanism to inflate the currency. Back in time when dollar was backed by gold it was possible for the system to exchange some assets for gold abroad and use this gold to reflate the dollar. But in the fiat currency system the gold doesn’t matter and the Feds have no legal basis to print money. They will do that if the congress allow them, but so far I’m not aware of any movements in the congress to allow printing the money.
So why I think the dollar goes up, at least for now? Remember, the liquidity in the system exists in two forms – money and debt. Money is claim for goods, debt is claim for money. When lenders are refusing to extend the expiring credit lines the borrower is scratching in his pockets to meet his obligations, which usually means selling assets. So the price of all assets is falling against the dollar, or you can phrase it that the purchase power of the dollar is rising. And the price of some assets is falling below the perceived fair value, which makes the dollar a particularly interesting currency – it’s not that piece of paper it used to be when pretty much any asset used to outperform cash
Cash is king (our generation forgot what it is)