George Bush has turned the phrase "sound as a dollar" into an anachronism. The books have been cooked, with net external debt almost twice as large as officially reported. The recent rallies in the US market are hedged with a rise in put options.
Brad Setser writes
: Nouriel and I postulated back in early 2005 that there was a meaningful risk that the next “emerging market” crisis might come from the US
as the American debt monster finds it no longer could place its debt with the world’s central banks, the dollar would fall, market interest rates would rise, US debt servicing costs would go up, the economy would slow and the value of a host of financial assets would tumble....Currency collapses do not necessarily translate into economic slumps. ...The US, thankfully, has financed itself by selling dollar-denominated debt, pushing currency risks onto its creditors. ...
I certainly didn’t see this kind of global sell off of emerging economies coming, though I worried about a few specific markets. ...
A big fall in the dollar isn’t bad for the US. A big fall in financial inflows that led to a rise in US interest rates though is another story.
Daniel Gros in the Financial Times
, quoted on Brad DeLong's site
[I]t is likely that the true US net external debtor position is around $4,000bn (about 40 per cent of GDP) rather than the $2,500bn reported officially for end-2004... both the current account deficit and the net debtor position of the US are even worse than officially reported. This can only mean that the need for a substantial depreciation of the dollar and/or a period of sub-par growth is even bigger than generally accepted..
Bill Gross of PIMCO
: We're about 4% dollar short and that's about as much as we can be. That may sound like nothing, but that position does represent our maximum confidence that the dollar is going down in the next several years. We can't gauge imminent weakness of the U.S. economy any more than Bernanke can, but this is for us a several years' bet. And we're willing to suffer ... if we have to. Because we are expecting the economy to slow and housing to crack and Bernanke to start thinking about lowering rates, that basically suggests that you don't want lots of credit risk.
The sentiment index
, which seemed as if it would rise on Friday, ended at 77, meaning that traders are betting on a further drop in the US market. In effect, they bought stocks, but hedged that buying with puts. In the short term, they may be squeezed. In the long run, we will be.