"The dollar looks awfully like sterling after the First World War," said David Bloom, the bank's currency chief.

"The whole picture of risk-reward for emerging market currencies has changed. It is not so much that they have risen to our standards, it is that we have fallen to theirs. It used to be that sovereign risk was mainly an emerging market issue but the events of the last year have shown that this is no longer the case. Look at the UK - debt is racing up to 100pc of GDP," he said

The Telegraph reports:

"Crucially, China and rising Asia have reached the point where they can no longer keep holding down their currencies to boost exports because this is causing mayhem to their own economies, stoking asset bubbles. Asia's 'mercantilist mindset' of recent decades is about to be broken by the spectre of an inflation spiral.

"The policy headache was already becoming clear in the final phase of the global credit boom but the financial crisis temporarily masked the effect. The pressures will return with a vengeance as these countries roar back to life, leaving the US and other laggards of the old world far behind.

"A monetary policy of near zero rates - further juiced by quantitative easing - is completely incompatible with circumstances in most of Asia, the Middle East, Latin America, and Africa. Divorce is inevitable. The US is expected to hold rates near zero through 2010 to tackle its own crisis.

"What is occurring is an epochal loss in the relative wealth and economic power of the old G10 bloc of rich countries compared to rising regions of the world. The euro, yen, sterling, Swiss franc and other mature currencies will be relegated along with the dollar in this great process of rebalancing, but the Greenback will bear the brunt."

That said, we repeat a headline from Seeking Alpha:

"Dollar shorts should look out."

We agree with HSBC and the Telegraph: the dollar will probably slide - especially against Asian currencies - for the next few decades.

But that's the long term. In the relatively short term we still face the shock of another leg down of the credit contraction crisis. Risk is likely to make a comeback. When that happens - and it could happen in a 'Red October' - the dollar will seem like a relatively solid refuge. This is what happened last year. We wouldn't be surprised by a replay of that 'flight to safety' we saw at the end of last year.

But we know what you're thinking: what? When did the dollar become a 'safe currency?' Of course, it's not safe. But when the end of the world approaches, it will seem safe.

For a while.

Until tomorrow,

Bill Bonner
for The Daily Reckoning Australia

• The Dollar Left Behind
• Will Synchronized Rate Cuts Solve International Financial System Problems?
• Where Do the Feds Get Any Money?
• Fed Vice Donald Kohn Urges Emerging Markets to Drop the Dollar Peg
• Prices of Gold in the Top 10 World Currencies

The modern 1930s are the logical consequence of the "New Economy" of the past decade, just as the original was a logical consequence of the "Roaring Twenties." In each case, technology and leverage combined to create a potent but ultimately poisonous brew of wildly inflated asset prices. In essence, greedy CEOs (and investment managers) said, "we brought you the new economy, please cash us out now." And a gullible American public affirmed this by bidding up prices to insane levels, expecting to share, rather than subsidize, the wealth of the selling shareholders. First the tech companies, then the financial intermediaries were then caught in traps of their own making, and escaped as sorely crippled entities, if they survived at all. But by this time, the more privileged players had "taken their money and run."

Probably without meaning to, the Los Angeles Times aptly summed things up with an article headlined "A New Great Depression? It's Different This Time." The aptness is if you interpret the headline as "The Depression is Different This Time" as opposed to "Things Are Different This Time." The details will naturally differ from those of the 1930s, but the substance will remain the same. But the paper dismisses the popping of asset bubbles in housing and stocks as merely "disturbing parallels." Working together, the Fed (and the modern J.P. Morgan) "saved" Bear Stearns, the modern Bank of the United States, thereby preventing a collapse of the banking system. International trade remains robust, at least for now. So things don't seem to bad, at least to the Times.

But are things really that different almost 80 years later? For instance, the popping of major asset bubbles almost defines a recession by itself. And one can argue that the 1930s collapse of the banking system is the consequence, or reflection of the real economy, rather than its cause. So saving one insolvent institution isn't going to prevent the unraveling of the rest of the system early in the new century. And yes, the international situation is okay, but that's just because America is the cause, rather than the recipient, of global economic problems this time around; falling stock prices abroad are saying that foreign GDP growth will soon collapse as a result of America's troubles.

In deciding whether or not we are headed toward depression, one needs to look at the substance of economic events, as opposed to the form. Some examples of the substance: 1) A post-war record level of home foreclosures headed to 1930s levels fueled by a similarly record collapse of home prices. 2) Several major "runs on banks" as investors begin to wake up to the fact that a lot of what passes for collateral is in fact worth very little. 3) A panicked Fed trying to head off a financial panic by simultaneously lowering interest rates and injecting money into the system.

And what's worse, we are only in the early stages of the crisis. Last year, 2007, was the year that the mortgage market unwound. This year, 2008, will feature the collapse of major financial institutions, starting, but not ending, with Bear Stearns. Next year, 2009, will be the year when the problems make their way to the rest of the U.S. economy, including the still-buoyant industrial sector. By 2010, the recession (or worse) will be global.

Some take comfort in the fact that we haven't yet seen soup lines, or 25% unemployment. But soup lines are merely an unnecessary (and hopefully unrepeated) appendage of the above. And anecdotal evidence suggests that many welfare agencies are now stretched to the absolute limit, meaning that new soup lines will appear if the system is tested just a bit more. And unemployment hasn't risen because companies have so far chosen to cut health care and pension contributions rather than lay off workers. One can easily get to the 1930s 25% unemployment with a 0% headline unemployment rate - by assuming that half the work force will be "temps" working half time without fringe benefits.

But perhaps one of the better definitions of the modern 1930s was given in a previous article on this site - a two decade pullback in the American standard of living to the 1980s (the original took American consumption back to the 1910s). Such a pullback seems inevitable from the deleveraging and loss of wealth that is now taking place. Moreover, such a retreat would last for an extended period of time. That's because we had the best of all possible worlds (relative to the true state of the global economy) for most of the past decade and half. The next decade and half will probably see the worst of all such worlds.

Regards,

Tom Au
The Daily Reckoning Australia

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