Dollars, Debt and the Trade Gap, Thoughts on the Dropping Dollar (19-12-06)

According to some economic analysis in today's Wall Street Journal, possible radical change in the value of the dollar in the near future might have provided some good reasons for the short-term capital controls instituted by the Thai central bank this week:

"And I think observers are nervous because they are wondering if a dollar decline will trigger a more fundamental set of moves on the part of central banks and other quasi-state entities -- in terms of holdings -- and on the part of private actors like hedge funds. The importance of hedge funds, combined with the rapid expansion of derivatives markets injects a heightened degree of uncertainty into the current situation."

"In other words, while investment bank and professional forecasters are predicting a slow and steady depreciation of the dollar over the next year, a sharp move in the dollar might push the system over a tipping point so that a much more discontinuous decline occurs. If market participants are myopic, that provides yet another scenario for a big drop."

"There's a well-developed economics literature that explains why exchange rates that move by a large amount tend to do so abruptly. In a nutshell, the idea is that as soon as people start feeling that a substantial currency drop is imminent, everyone tries to dump it at the same time, ensuring that the fall becomes precipitous. (Paul Krugman provides a nice summary of the classic economic literature on the subject.)"