naked capitalism

Our mantra of late has been that the serial bailout plans from the Treasury and Fed will undermine the US’s AAA rating and exact a considerable toll on the dollar. Indeed, Liam Halligan tells us in the Telegraph today that “Default by the US government is no longer unthinkable.”

Bloomberg reports that this view is on its way to becoming conventional wisdom among traders. And trashing the dollar will have decidedly nasty effects of food and energy prices, further pressuring an already deteriorating economy.

From Bloomberg:

Treasury Secretary Henry Paulson’s plan to end the rout in U.S. financial markets may derail the dollar’s three-month rally as investors weigh the costs of the rescue.

The combination of spending $700 billion on soured mortgage-related assets and providing $400 billion to guarantee money-market mutual funds will boost U.S. borrowing as much as $1 trillion, according to Barclays Capital interest-rate strategist Michael Pond in New York. While the rescue may restore investor confidence to battered financial markets, traders will again focus on the twin budget and current-account deficits and negative real U.S. interest rates.

“As we get to the other side of this, the dollar will get crushed,” said John Taylor, chairman of New York-based International Foreign Exchange Concepts Inc., the world’s biggest currency hedge-fund firm, which manages about $15 billion.

The dollar fell against 14 of the world’s most-traded currencies on Sept. 19, including the euro, as Paulson unveiled the plan, while the Standard & Poor’s 500 Index rose 4 percent….

Yves here. A peppy stockmarket and falling currency are not an unheard-of combination. Reader Scott has pointed out more than once as the Zimbabwe dollar has collapsed, its stockmarket has performed spectacularly in local currency terms.

“The downdraft on the dollar from the hit to the balance sheet of the U.S. government will dwarf the short-term gains from solving the banking crisis,” said David Woo, London-based global head of foreign-exchange strategy at Barclays, the third- biggest currency trader…..

“After years of doubting the hegemonic status of the dollar, this proves it’s still there,” said Stephen Jen, London-based head of research at Morgan Stanley. “But of course this situation is definitely not stable. The capital leaving the emerging markets is only going into the dollar and that’s a powerful force. It’s a very uncomfortable balance.”…..

Although the dollar may suffer short-term, at least one analyst says the U.S. government’s planned rescue will strengthen the currency before long…..

“It’s a positive plan that’s ultimately good for the dollar,” said New York-based [Adam] Boyton [senior currency strategist at Deutschebank]. “It reduces risk and volatility and gets the focus back on macroeconomic fundamentals, which suggest weakness throughout the rest of the globe next year, with returning strength in the U.S.”….

“Investors may start to worry about the amount of debt the U.S. is taking on and its impact on the dollar,” said Geoffrey Yu, a currency strategist in London at UBS AG, the second- largest foreign-exchange trader. “The fact that they mentioned taxpayer money implies that they’re going to issue debt. If there’s going to be a huge new supply of Treasuries, this will be dollar negative. It’s too much for the dollar to take.”

Traders are also concerned the bank bailout will spread to other U.S. industries suffering from the credit crunch….Lower interest rates may also weigh on the dollar…..Another drawback for the dollar is that the Fed’s key rate is 3.4 percentage points less than the rate of inflation, the most since 1980, so investors lose money by investing in short- term U.S. fixed-income assets.