Whither the dollar?

Today's report, showing a sharp rise last month in the foreign purchase of US debt instruments (treasury bonds, corporate securities) appeared on its face to be good news for the dropping dollars. Indeed, it brought a quick reaction of the Forex market, in which the dollar gained a penny against the euro, which fell from $1.34 to $1.33.

But the underlying data are troubling, because, as has been rumored in recent weeks, it appears that the foreign governments (Japan, China, chiefly) in fact cut back their purchases, whereas foreign-based private hedge funds increased theirs mightily last month. As the Reuters analysis points out, monthly fluctuations in the amount of these private purchases are great, leaving the prospect of an upcoming period, not long from now, when there'll be neither private nor governmental foreign purchase of our equity and our debt, which presently accounts for one fourth of the market for such securitites. Such a vacuum would immediately cause a rise in interest rate of our debt to attract purchasers, and could trigger further inflationary fears. The likely result: The dollar would weaken even more as it cheapens, the dollar debt would become yet less attractive, and the interest rate needed to peddle that debt would rise further, starting a spiral of inflation, increase of interest rates for all kinds of borrowing in the US, and loss of buying power for US consumers, a credit-saddled bunch, who are, after all, the only engine our economy has.

It could get real ugly, real soon.