Thursday, October 21, 2010

The First Signs of the Coming Dollar Crash are in Hong Kong

By Simon Black

I'm seeing some things on the ground here in Hong Kong that are the first signs of a coming dollar crash.

We've talked before about how the global financial system is based on enormous flows of capital-- trillions of dollars flow from one country to another, from one currency to another, and most of it is controlled by large banks, funds, and institutions.

This system requires extremely large economies with extremely large money supplies that can adequately absorb huge capital flows. If you and I go buy a few thousand dollars worth of Peruvian sols, for example, no one will notice. But if JP Morgan decides to buy $1 billion worth of Peruvian sols, the Peruvian sol is going to spike.

As such, there are really only three places in the world where the currencies can absorb huge capital flows-- the US, Japan, and eurozone. Coincidentally, these are also among the three sickest developed economies.

Everyone knows that the US has the largest debt in the history of the world, that the eurozone's supranational challenges are beyond repair, and that Japan's 2-decade long recession shows no signs of abating... but frankly there aren't any other options out there.

Trillions of dollars of institutional money need to be parked somewhere, and as much as institutions might like to hold their cash in a better store of value like, say, the Chilean peso, there simply aren't enough Chilean pesos in existence to absorb trillions of dollars.

This means that institutional investors are essentially left to judge a redneck beauty pageant: which of the three contestants is the least ugly?

The winner fluctuates. For the six months from September 2008 through March 2009, the dollar was the least ugly. Then for the next 6-months until November 2009, the dollar was the ugliest.  From November 2009 through May 2010, the euro was the ugliest, and since May it appears that the dollar has once again been deemed the ugliest.

Undoubtedly, the Japanese yen will have its time in the spotlight as the ugliest, and we'll continue to see all three of these currencies jockeying for position against the others.  Their respective bureaucrats favor weak currencies, and they're doing whatever they can to inflate and devalue.

In the meantime, little by little, some of these institutional flows are spilling into other currencies viewed as safer stores of value... hence the rapid rise of the Swiss franc, Canadian dollar, Aussie dollar, New Zealand dollar, Singapore dollar, Chilean peso, Brazilian real, and of course, precious metals.

For institutional funds, though, these currencies don't necessary offer a long-term solution because they're too small. The entire money supplies of Australia and Canada, for example, are each about $1.3 trillion, while the value of all the available precious metal is less than $6 trillion.

Meanwhile, the Bank for International Settlements estimates the size of the world bond market at over $80 trillion. Thus, you can see why institutions are having to play judge in such an unfortunate beauty pageant... there simply aren't any reasonable options to hold vast amounts of currency.

As one of the world's strongest and most dominant economies, China's renminbi represents a long-term solution... but not yet. China's economy is already #2 in the world and will likely overtake the United States within a decade. Its money supply is vast, and would be able to withstand significant capital flows.

Read more here.

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