Friday, December 5, 2008
How does US currency status affect capital flows
The position of the U.S. dollar as the premier international currency since the end of the gold standard in 1971, has resulted in a worldwide habit of accumulating savings in dollars. This has led to an excess of imports over exports (the trade deficit) and in international players having an increasing amount of dollars to invest. Foreign holders of dollars have long shown preference for fixed income investments over equities. Therefore, the increasing volume of dollars held by foreigners has put upward pressure on bond prices. The long up trend in U.S. bond prices since the 1980s is directly correlated to increasing foreign trade deficits. Other things remaining the same, we would expect bond prices to continue to rise along with the trade deficit. Therefore, the driving force behind the long-term rise in bond prices has been the desire of foreign exporters to sell goods to the U.S. in order to accumulate dollar assets.