Recently by Simon Black: It'll Never Happen to Me
There’s major shift occurring right now in financial markets.
Sure, the food and freedom riots that are spreading across the globe are a major indicator that civil unrest follows very closely behind resource shortages and economic turmoil… but there’s something else that I’ve noticed recently – it’s a sea change in the financial system.
In the past, major crises normally caused investors to seek safe haven assets, and everything else equal, the dollar would rise. They call it a ‘flight to safety’, and investors would flock towards the perceived stability of US Treasury securities.
In 2008, for example, the Lehman collapse spurred the market to go rushing into the dollar. The pound, euro, S&P, oil, and gold all went into freefall, and the dollar surged. Anyone holding cash felt pretty smart, and the market paid tribute to the US dollar as the world’s safe haven currency.
There were a lot of reasons for why this happened. The US government likes to claim that it has never failed to pay on its debts. Of course, even the most cursory analysis would lead one to conclude that they trade debt for inflation… and more debt.
Regardless, when financial markets were collapsing in 2008, investors made a rational decision to accept negative real rates in the dollar (effectively paying a fee to hold short-term treasuries) over other currencies and asset classes.
It was the lesser of all evils at that particular moment and should not be conflated with ‘confidence’.
The other big reason for the dollar’s 2008 surge was that many of the world’s financial markets were leveraged to the hilt… in dollars. When Greenspan started slashing rates in 2001, investors around the world had been able to borrow cheap US dollars and park them in higher yielding assets abroad.
This global carry trade helped produce huge returns in emerging financial markets as investors borrowed four to six times their dollar equity at 2% to 8% and invested in China at 20%+.
When those markets began to melt down, however, the dollar loans needed to be repaid, and investors went rushing back into the dollar.
The dollar sat atop its altar for about six-months from September 2008 through March 2009, at which point risk tolerance reversed and the dollar began steadily losing ground again.
When European sovereign debt woes surfaced later that year (and in earnest in early 2010), the dollar surged once again… but that time it was a little different.
Sure, the dollar rallied against the euro and other European currencies… but gold rose as well. I remember writing about this last year, suggesting that the simultaneous rise in both the dollar and gold indicated the market’s changing attitude towards what it considered a ‘safe haven.’