The de-leverage in the market to adjust back to normal risk levels is decreasing the money supply substantially, they are trying to inject huge sums of USD into the market to offset that. All in all, the functional money supply is actually down substantially. Also, a very large portion of the USD money supply is generated from the Eurodollar market, which has better interest rate terms on both the deposit and lending side of the equation. Since they do not have to maintain a specific percentage on deposit, the Eurodollar market can actually turn over USD at an infinite multiple and do it more quickly at equilibrium interest rates. I don’t think they even include that in M3 money supply anymore because they can’t keep track of the actual amount or control it. As rates come back up in U.S. they deposit more proportionally here than in the Eurodollar markets and overall money supply actually drops due to the addition of the multiple on turnover.
Also, if inflation escalates (and it will because China, Brazil and India aren’t going to stop with their infrastructure growth booms) we are going to have to raise interest rates. Many of these other countries are just starting rate cut cycles. The Eurozone and UK are about a year behind us in the financial crisis, so they still have to go through portions of this we have already been through. The financial crisis is caused from a leverage problem having taken increased risk in easy markets the last 10-12 years, both from banks and the average investor. Eurozone and UK banks historically take on more leverage than U.S. banks because they have always had stronger government backing, so they most likely have to de-leverage even more than the U.S and this will hit them even harder.
No matter how you slice this banking issue. Ultimately, as the risk gets factored back into the markets, equilibrium interest rates have to RISE. The open market has already started factoring that in…Fed Funds opened at 7% yesterday morning…that’s why the banks won’t lend at lower rates involving higher risk even at the currently higher spreads. Rates have to rise and when rates go back up, USD will go back up. Right now they are just shifting the excess risk in the markets to treasuries, which is making the spreads even wider.
Regions like China and Dubai are sitting on HUGE sums of liquidity, the second we start to recover that money is going to come to the U.S. and not go to the EUR which is just starting to see a lot of the problems.
With the stresses in the Eurozone coming, people realizing it’s a new currency, and the widening variances between the economic makeup of the countries involved…the ECB decisions become even harder to make without excess benefit to one country while excess loss to another. What is good for Germany is not good for France and the moment people hear that even one country starts to have even casual discussion about leaving the Euro currency, whether serious or not, we’ll begin to see how unstable EUR can be real quick compared to USD. The Eurozone has never had to go through anything less than a booming global economy since it’s inception and they were barely able to put it together in the first place. Trichet himself hinted at this earlier, when he said there is no “United States of Europe.” They only have a monetary union, not a governmental union.
I may be wrong, but I wouldn’t short USD right now if you put a gun to my head.