Will the Dollar Rally When the Market Next Crashes?

The big news of the day is obviously the weak dollar.

As the headline of a must-read article in Bloomberg states: “Dollar Reaches Breaking Point as [Central] Banks Shift Reserves [Away from the Dollar]”.

AFP points out that – whether or not the report from the Independent that many countries will price oil against a basket of currencies and gold in the future is true (see this and this) – confidence in the dollar is so weak that investors and banks are using it as an excuse to get out of the dollar.

Business insider notes that the S&P has fallen back to 1996 levels in dollar-adjusted terms.

Obviously, the trend line for the dollar is going down in the medium to long-term.

And yet there are strong arguments for a short-term dollar rally the next time the market crashes.

The key question is whether the dollar will behave the same way it did in the 2008 crash. The currency chief at HSBC – David Bloom- doesn’t think so:

The dollar rallied last year because we had a global liquidity crisis, but we think the rules have changed and that it will be very different this time [if there is another market sell-off].

But the dollar wasn’t the basis for a carry trade last year. If the markets crash, the dollar trade may unwind, pushing the dollar higher.

Moreover, does the fact that many top economists say that it was not really a liquidity crisis but an insolvency crisis undermine Bloom’s argument?

It is vital for investors and financial analysts to figure out whether or not Bloom is right. If he’s wrong, then getting out of the dollar to soon would be counterproductive. If he’s right, getting out too late would be suicidal.

Marc Faber actually argues that it is the other way around: when the dollar rallies, then the markets will tank, as investors will suck money out of the markets to buy the dollar.

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  • The reverse is the case: When the dollar rallies — and it inevitably will when "everyone" is short a "sure thing" — the market will crash, and the dollar carry trade will unwind.It's not a matter of how many are talking bearish about the dollar, but now many are putting their money where their mind is and going short on a "sure thing." Right now, "everyone" is saying that the dollar has only one way to go. Right.There is no fundamental reason that the yen and euro are worth more than the dollar. Japan is tanking fast, and European finance is in worse shape than US. Europe just has a better safety net than the US, so their economies have an automatic stabilizer built in. But the financiers? Way out on a limb.