Levels of debt in excess of amounts which can be serviced from current income result in deflation. You avoid deflation by either getting rid of the debt or by increasing income. The inflation answer cannot work unless it can be accomplished in a process which increases income. Not only is that not happening now, it is difficult to come up with a hypothetical state of affairs in which increased liquidity provided through the bank fractional reserve process can result in increased income (in the real estate market but there is some finite limit there which I believe has been reached; maybe some other limited sector asset based areas for limited periods of time; but none of that is sustainable to cause a real expansion of income).
The interest rate differential explanation for the bounce in the dollar seems to be the conventional view--and may be correct. Thing is the result has come from a pretty small difference in a very short period of time.
How does unwinding the carry trade cause the dollar to go up against the Euro?
As to the long term trade deficit issue, if the domestic economy continues to deteriorate, US customers will reduce offshore purchases and the offshore economies will also contract. Since US consumption is the primary market, the offshore economies will suffer more from contraction in the US than the domestic economy does.
I see the real underlying dollar weakness emanating from long term lack of current liquidity flow to pay market interest rates.
The carry trade was put on by borrowing dollars at historically (hysterically?) low rates and reinvested (USD sold) in higher yield/risk assets.
The carry trade is unwound by selling those higher yield/risk assets for dollars (USD bought) which are then used to repay debts.
The unwinding carry trade reverses a 2-3 year trend of borrowing/selling of USD to a trend of buying/repaying USD. Buying USD and taking them out of the money supply by repaying debts puts upward pressure on the USD.
Foreign Central Banks also continue to support the USD & Treasuries, and interest rate derivatives may be getting exercised which involve dollar buying to cover hedged positions, (point being, an unwinding carry trade is not the sole factor), and the short term USD rise is not against EUR only, but against many currencies, especially the commodity currencies.
I agree with sourcery it looks like the yield curve is about to invert.
Perhaps you could elaborate on the mechanics of this process? How does an aggregate inability to service loans (in full or in part) cause the money supply to contract, or at least contract faster than goods/service contract? Whatever that answer is, how does it prevent the Fed from printing money and buying back Treasuries (monetization of Govt debt)?
The inflation answer cannot work unless it can be accomplished in a process which increases income. Not only is that not happening now, it is difficult to come up with a hypothetical state of affairs in which increased liquidity provided through the bank fractional reserve process can result in increased income....
I contend it is happening now on a global scale. The US Federal Reserve and GSEs are inflating the USD money supply, the Japanese and Chinese are inflating their money supplies to sterilize their USD profits. Incomes are increasing in India, China, South America - the bulk of the worlds work force. They are buying food, cars, air-conditioners, cell phones, etc. Their governments and employers are buying up commodites and companies to make & power all that stuff.
As to the long term trade deficit issue, if the domestic economy continues to deteriorate, US customers will reduce offshore purchases and the offshore economies will also contract. Since US consumption is the primary market, the offshore economies will suffer more from contraction in the US than the domestic economy does.
Yes, and the 'solution' will be to do what Central Banks and governments always do - stimulate their economies with debt-based expansion and increased liquidity, except the target beneficiaries will be their own populations instead of the US.
But the pumping of the money supplies will continue. Debt being monetized in the US, and competitive currency debasement amongst the Asians & Europeans.