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The most important decision we take is which currency to hold our wealth in. All else are just footnotes. In the long-term currency values are determined by productivity trends, but in the medium-term Central Banks and savings flows matter alot.
The recent jump in forex volatility is understandable. A similar theme coloured the mid-to-late 1930s. As we have previous remarked, the French Franc was then very very strong until it was very very weak. The collapse in the Franc destroyed much of the wealth of France's then middle class. Eighty years on we are seeing another bout of competitive devaluations? Sterling is just the latest example.
But why do so many seek to cheapen their exchange rates? We figure the reasons lie with the dollar. Not only has America become much more competitive over the past five years and able to compete with any EMs, but her liquidity and savings flows are strongly supportive of a rising US dollar. Two things are important here. First, unlike the QE1 and QE2 periods, QE3 will not see dollar weakness. Second, a strong dollar is the biggest threat that risk assets face in 2013. Surprisingly this threat gets little air time. Add up America's surging savings flows; the jump in wholesale funding by banks in the last 6 weeks; the shale oil boom and the narrowing current account deficit, and you may agree that the rest of us might soon be starved of dollars.
If the latest FOMC minutes are taken at face value, a stronger economy ( its coming) will persuade policy-makers to slowdown QE3. At that point stand back and watch the dollar soar. Even gold, once everyone's friend, is now being shunned. The bottom line is that our Liquidity data has been warning for some months of coming dollar strength. It may just have arrived?
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