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santiago: The answer is no, not right. The demand for dollars would have been the same, and that also explains why the idea of currency baskets is problematic too.

I'm probably banging up against my cognitive limits here, but here are two more ways I've been trying to understand this:

1.  Suppose we reduce the situation to an absurdly idealized simple situation, in which there are only two countries/currencies in the world, A and B, and their respective currencies happen to have a 1:1 exchange rate.  Now let's say there were a massive amount of debt denominated in A currency being held by B citizens and entities.  If those B borrowers had to repay that debt in A currency, then they probably would have to exchange large amounts of B currency for A currency, thus driving up the value of A currency with respect to B currency.  Is that correct, so far?

On the other hand, if those B borrowers were allowed to repay their debts in B currency, then the exchange rate would not be affected, or at least, not as drastically.  Is that correct?  Or am I missing some major factors?

If this scenario makes sense (a big if), then I don't see why the dollar would have gone up so suddenly against most major currencies if debt holders could pay back their debts in those currencies.

2. Another take I was wondering about:  What if Switzerland, not the U.S., were the source of all the mad financial shenanigans and most of the debt were denominated in Swiss francs and had to be paid back in Swiss francs (again, another fantasy, but...)  In this scenario, wouldn't we have seen a rush for Swiss francs and a corresponding rise in the value of the CHF?  If so, that would not be evidence for the relative pre-eminence of Swiss political authority in the world, would it?

Lastly, out of curiosity, I looked up the graphs for the last year's exchange rates of the US dollar against other major currencies, which with one exception of the yen, did show a steep rise of the US$ in the aftermath of the crisis.  Now, I believe the precipitous rise of the yen against all major currencies, including the US$, was due to a circumstance that was quite "prosaic", "technical", "artefactual", whatever you want to call it, related to the yen carry trade.  More to the point, the rise of the yen was not evidence of global investors' faith in Japanese political authority, but rather to the abnormally large extent of the yen carry trade.  If that is the case, then how can the rise of the dollar vs. other major currencies (other than the yen) be taken as evidence of faith in the political authority of the U.S.?

santiago: The reason is that there is nothing -- or not much anyway -- contractual, legal, or otherwise, that requires banks (or other investors or creditors) to keep the currency in their vaults in US dollars today.

But are they keeping their currency in US dollars today?  I doubt you can answer that by looking at exchange rates alone, but doesn't the steady decline of the dollar against all other major currencies in the graphs  below suggest that people are not in fact keeping their currency in dollars?

USD vs. Euro

USD vs. Swiss France

USD vs. UK Pound

USD vs. Chinese Renminbi

USD vs. Canadian Dollar

USD vs. Japanese Yen


The West won the world not by the superiority of its ideas or values or religion, but rather by its superiority in applying organized violence.

by marco on Thu Sep 3rd, 2009 at 05:39:47 AM EST
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