Worrisome Clouds Gather Over US Dollar

I recently wrote about a major insult to the U.S. dollar that hadn't been widely reported. And late last week, that news got compounded with more worrisome news, which was once again not widely reported.

What is one major reason that upholds the U.S. dollar as the Reserve Currency? It is certainly not the inherent strength of the U.S. dollar or the strength of the U.S. economy.

Even after the weakness we have seen here in the United States, we see the U.S. dollar rise in value. Why?

The reason for this absurd behavior is simple – fear..

When the world goes into a mode of fear, it rushes to U.S. dollar. Whether the U.S. dollar is safe or not, the investor believes that this is the safe haven of the last resort and that the U.S. debt market is deep enough to absorb the liquidity.

The reason the U.S. dollar is considered safe is because of the liquidity and depth of the debt market. This means the investor buys U.S. dollars and invests it in U.S. Treasurys and U.S. debt.

Even the United States has been arrogant about this, trying to take the easy path and not suffer hard reforms because of the rationale: “Where are the investors going to go? There is no credible, deep debt markets anywhere which can absorb the liquidity volumes and the investor has to turn to America.”

This has caused some of the laziness in enforcing hard measures and difficult reforms in the U.S. markets.

The lack of a deep and unified debt market also ails Europe. Had there been a unified and deep debt market across Europe, some of the solutions would have become more feasible.

I have always worried about what can cause the trigger for the U.S. dollar to lose its reserve status. While I am not saying we have a challenge to the U.S. debt market today, I see the start of the challenge.

The largest economies outside the United States are Japan and China. And I had reported that China and Japan have entered into an agreement to trade in non U.S. dollar terms. To add to the woes, South Korea has decided last week to get the Chinese bond markets approved for investments. And China has agreed to allow South Korean pension funds to invest in Chinese bonds.

This is indeed worrisome. I see the initial fledgling signs of an Asian debt market forming.

If Japan, and now South Korea, start investing in China debt markets and then China ropes in Australia, New Zealand (who depend on China for its success) and then rope in Singapore, Malaysia and Indonesia, whom they can bully, we start seeing a serious threat of investors who used to invest in U.S. debt markets, now diversifying the investments in two markets and then gradually the stranglehold on the U.S. dollar will tighten.

It is time to diversify out of the U.S. dollar.