Consider the speed of the dollar’s ascent. The US dollar index, after falling from late 2005, went down to a low of 70.96 on 14 March. It then trod water till 21 July, when it was at 71.89. Thereafter it went up like a rocket, rising to 87.27 on 27 October. The last time the index was at that level was in July 2006. In other words, the dollar index recovered in three months all the ground that it lost in two years. It is this speed at which it has risen that has thrown corporate hedges out of whack and forced central banks in emerging markets to intervene heavily to support their currencies. Last Friday, the dollar index had risen to 87.42.

Will dollar strength continue?

Most market participants believe the deleveraging process still has some way to run. Many believe the next shoe to drop is likely to be credit card debt in the US, which will lead to another round of losses at banks and hence to another round of deleveraging.

Boston Consulting Group’s managing partner Daniel Stelter believes that the dollar could strengthen for the next few months as the deleveraging continues. Morgan Stanley economists Stephen Jen and Spyros Andreopoulos point out: “The world had been selling the dollar for six-and-a-half years, buying the euro and EM (emerging market) assets. Just like other trends we have witnessed in the past seven years, the reversal of the US credit cycle will likely lead to an unwinding in these USD (dollar) shorts. The size of the USD shorts, before EUR (euro)/USD began to sell off in July, had not been fully appreciated by investors. But the strength of the recent dollar rally suggests to us that the world remains short on the dollar."

In fact, while a level of 87 on the dollar index may seem high compared with levels three months ago, it’s worth remembering that the index had reached a high of 91.53 in September 2005 and it went as high as 119.82 in September 2001, the level from which it started falling. Simply put, emerging market currencies, including the rupee, could therefore remain under pressure.

Later on, however, after the dust settles, the dollar may well start to decline and there’s a lot of worry that all the liquidity unleashed by the US Federal Reserve will effectively devalue the dollar. “The US has no alternative to inflate its way out of debt," said Stelter, which will be very negative for the dollar.

But with the G-20 summit having ended with a whimper and with the US treasury secretary’s volte-face on the TARP (troubled asset relief programme) rescue package, all the authorities seem to be doing is to react to every emergency. Increasingly, the authorities are appearing more and more clueless, without any plan to get us out of the mess.

Until this crisis of confidence is overcome, the dollar is likely to continue to strengthen.

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