Watch the Dollar

The dollar has appreciated strongly on world markets since the October Crisis began -- around 15% on the Canadian dollar, the euro, and the British pound. The banter on the financial talking head shows is that this reflects a flight to quality. This is an interesting thought. Financial markets in the United States are on a roller-coaster, the mortgage-backed securities market has collapsed, the Federal Reserve is more or less printing money, and the pundits talk quality. There may be more at play. The current financial crisis has involved a collapse in the credit mechanisms that modern economies rely on. The machinery that creates credit has become frozen. As a result, while the central banks pour money into the fuel tank of the commercial credit engine, this has not led to actual creation of financial credit. Rather, the broken "credit multiplier" means the supply of dollars and related dollar credits at the market level has dropped. With an effective shortage, the price has gone up. Europe has been more aggressive in taking steps to restart its credit mechanisms in this regard. Hence, the rise of the dollar may signal the continued relative failure of dollar-denominated credit mechanisms. This might not be a flight to credit, but a collapse of supply.  As recent new proposals to insure inter-bank loans come on line (and if this is expanded further to cover commercial loans), a signal of a successful restart of the credit machine in the U.S. may ironically be a drop in the dollar as the flow of dollar-denominated credits expands again. Watch the dollar.