The Dollar is dropping and no one knows why

The dollar has been dropping over the last couple of days and no one really knows why. You can see some news stories on the subject here and here.

Macro Man has a post on the subject here. He runs through a list of possible explanations but I would be willing to bet that this explanation is the correct one….

Of course, there’s another participant in the market who moves large size without any obvious catalyst: Voldemort and the FX reserve managers. And there does appear to have been quite a flurry of activity on that front over the past few days. If this were to continue, it could easily push EUR/USD on to fresh all-time highs. And that’s one of the reasons that the currency market has been so frustrating to so many over the past few years. While the absolute magnitude of EUR/USD moves remains frustratingly small, the relative magnitude of moves when Voldemort comes to market, and the absence of obvious catalysts for him to do so, is relatively large. Which in turn makes EUR/USD very, very difficult to play as anything but a short-term technical proposition or a very long term vol bet.

For those that don’t read Macro Man on regular basis, I should point out that his pet name for China’s reserves manger is Voldemort. His point in the above passage is that market forces have had almost nothing to do with the price of the dollar for a long time now.

Because foreign reserve managers have such a large role in setting the price of the dollar, I have hard time believing people who want to claim that this market reason or that market reason is the cause of the fall of the dollar. How can you make that determination when we all know that market forces have very little to do with the price of the dollar at the present time? So many dollars are held in government reserves that the dollar could be falling simply because someone somewhere made the political decision that it should fall.

I am pretty sure that the current fall in the dollar is not related to market forces reacting to interest rates or other such market reasons. To my mind the real question is, does the current fall in the dollar reflect a short term readjustment of the relative compositions of world reserves or a fundamental decision to stop propping up the dollar?

If the serial reserve accumulators (of whom China is chief) are just rebalancing their reserves, the fall should be relatively short in duration. But if they have given up on supporting the dollar, it could be the end of the fairy tale.

Personally, I would guess that the current fall of the dollar is simply a reflection of rebalancing on the part of reserve accumulators. I have read some indications that many foreign exchange managers have been preparing to move in a more balanced direction for a while now. Besides, I don’t think that “Voldemort” will let the dollar really fall until he is forced to, and I don’t think that market forces are strong enough to win a fight with “Voldemort” yet.

But the broad based nature of the dollar’s recent fall gives me pause. I wonder if the ripples from a rebalancing might develop into something that is hard for “Voldemort” to control.

As I see it, “Voldemort” wants to rebalance its reserves without causing a major dollar drop. The problem is that there are a lot of market participants who are only in dollar denominated assets because they are convinced of “Voldemort’s” power. If “Voldemort’s” rebalancing causes other market participants to lose money, there could be a rush for the door that “Voldemort” cannot control.

But that is probably wishful thinking on my part. I wish to see this farce end sooner rather than later. But in reality, I don’t see any end to “Voldemort’s” power just yet. He probably needs to acquire another trillion for things to get really out of control.

One Response to “The Dollar is dropping and no one knows why”

  1. […] _uacct = “UA-1202685-1”; urchinTracker(); Map of the Ethereal Land The Ethereal Voice Front Page – Politics – Money – Knowledge – Art – Food – Fun Masthead About The Dollar is dropping and no one knows why By Ape Man | July 3, 2007 – 1:53 pm Posted in Category: Front Page, Money The dollar has been dropping over the last couple of days and no one really knows why. You can see some news stories on the subject here and here. Macro Man has a post on the subject here. He runs through a list of possible explanations but I would be willing to bet that this Click Here to continue reading. […]

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