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Wednesday, November 01, 2006

The Puzzled Club

Lose your shorts on the dollar:

Short for the long term, FreeExchange: ...We are tired of using the same old descriptions of America's current account imbalances that everyone falls back on—gigantic, humongous, titanic.... But it is hard to come up with an adequate metaphor to replace the overused superlatives. ... Since America is not going to grow its way out of its accumulated debts, it will need to import less and export more. The likely mechanism for this adjustment is a decline in the value of the dollar, which will make its exports more attractive to foreigners, while simultaneously making imports less attractive to Americans.

In today's New York Times, David Leonhardt chronicles Robert Rubin's entirely reasonable decision to short the dollar based on similar analysis of the situation:

A couple of years ago, Robert E. Rubin ... decided that the United States dollar was headed for a fall. This view put Mr. Rubin in good company. Nearly everyone who spends time thinking about the American economy believes that the value of the dollar has to fall at some point.

. . . a former colleague of Mr. Rubin’s at Goldman Sachs had been whispering in his ear that anybody who didn’t have 20 or 30 percent of his holdings tied to other currencies was “out of his mind.” Yet as Mr. Rubin told me last week, his finances at the time were “totally dollar-based.” ...

So he decided to bet against the dollar by buying options on other currencies. It turned out to be a very bad bet. America's former treasury secretary lost about $1 million before he finally gave up and closed his positions. No one had explained to the American dollar that it was doomed.

We feel his pain. Not because we are trying to short the dollar... [W]e need to forecast the future for a different reason: as economic journalists, it's our job. And the dollar has defied all of our very sensible, nay, incontravertible, predictions.

Eventually it will fall, and we (and Mr Rubin) will be vindicated. But until then we shall writhe silently under the pitying glances of friends and readers wondering how we could have got it quite so wrong.

Brad Setser is also puzzled:

The club of puzzled dollar bears grows bigger, by Brad Setser: I am – and probably always will be – a big Robert Rubin fan. Even if he isn’t as good a currency trader as Treasury Secretary. Indeed, all those of us who thought there was a big risk that the US would have a Wile E. Coyote moment two years ago can take comfort that both Bob Rubin and Paul Volcker thought so too...

I share Rubin’s deep sense of puzzlement. Not about the dollar. Central banks are clearly responsible for propping it up against the places that count, and the dollar isn’t that strong against places that don’t actively intervene. OK, the dollar/yen puzzles me a bit...

But what really puzzles me is the absence of volatility in the foreign exchange market. The pound trades like it is euro, and the euro/yen/dollar volatility has fallen. That of course is tied to the attractiveness of the yen/ dollar and yen/ euro carry trades...

Put a bit differently, I would expect, based on the collapse of capital flows to emerging economies in the 1990s, that a more unbalanced world will prove, over time, to be a more volatile world. But so far, though, it has been – at least in some key markets – a less volatile world. That puzzles me. ...

But at least I seem to be in good company.

    Posted by on Wednesday, November 1, 2006 at 05:34 PM in Economics, Financial System, International Finance | Permalink  TrackBack (0)  Comments (42)

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