More dollar drama — and the core reason for the carry trade

There’s a lot of chatter on the dollar front today. Treasury Secretary Tim Geithner told a group of Japanese reporters that he “believe[s] deeply that it’s very important for the U.S. and the economic health of the U.S. that we maintain a strong dollar.”

The Asia-Pacific Economic Cooperation forum is also up in arms about the falling greenback, according to the Wall Street Journal. Policymakers are reportedly prepared to give President Barack Obama an earful when he travels to Asia later this week. In the words of one delegate:

“Nobody in Asia, and only some in Europe, will speak publicly about their worries, but they are worried … The world — not only APEC, but the world — needs direction and the only country that can provide this direction is the United States. This can only be achieved through a stable U.S. currency.”

But in a candid moment, the Thai Finance Minister Korn Chatikavanij admitted that his country has wasted $15 billion trying to keep the baht from appreciating against the buck. And he verbalized what currency investors all know about the sorry state of the U.S. economy:

“But there is not much you could do to correct what is reality. The fact is when you’ve got that much debt … the only effective way of repaying that debt is basically devaluing your currency.”

In other words, all this is talk. The U.S. likely won’t do anything about the dollar decline as long as it remains orderly … which virtually guarantees at some point that the decline will NOT remain orderly.

By the way, if you’re wondering why the dollar is being sold in so many carry trades, the answer is quite simple. It’s the cheapest currency on the block to borrow! Three-month dollar LIBOR rates were recently 0.27%. That’s less than the 0.32% cost of borrowing Japanese yen … the 0.61% rate to borrow money in pounds sterling … and the 0.68% rate for euro-based loans. In other words, as long as the Fed continues to keep the taps wide open, leveraged global investors are going to get drunk off of the cheap money.

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