What goes around…

The falling dollar harms consumers of imports and imperils the U.S. reserve currency status, but unless something new and horrible comes along, we can see the general outline of developments. It’s not the kind of mindless panic that gets its grip on stock markets from time to time — the dollar’s decline is actually quite orderly. So what if the dollar goes to 1.50 or 1.55? At some point the euro will be overvalued, if it’s not already, and the pendulum will swing back in the dollar’s favor.

Also, at some point, as the euro will become a second reserve currency, Europe will start having regrets about being the issuer of a reserve currency — specifically, wild swings in money supply as users of the currency as a transaction medium and as a store of value change course. This is what happened to the dollar in the early 1980s as “petrodollars” came swarming in and out, rendering money supply practically useless as an inflation-management tool. European fixed-income markets in particular are not yet fully mature.

So, we observe the trend and we can easily understand the reasons for it, but we shouldn’t imagine it will go on forever. In the end, U.S. institutional robustness, transparency, variety, liquidity, and sheer size will reassert their attractiveness to global investors. But first we have to suffer through a period of revulsion lasting perhaps two to three more years, barring a global crisis.

It won’t be a one way street. As we are seeing, on the road to 1.45 and 1.50, sizeable corrections will still occur. Betting against the dollar wholesale is not a wise bet. And if a global crisis arises, e.g., the Shanghai index melting down, the dollar and U.S. capital markets will again be a safehaven.