Unstable Equilibria: $$$

The recent collapse of the Dollar vs. the Euro, Pound, and other dollars is not unexpected - the huge current account deficit made it inevitable. The problem is that this change doesn't quite do its Le Chatelier's Principle job - it doesn't move the world economy back to an equilibrium state. The problem is that the adjustment is taking place only between Dollar and Western currencies, while the export heavy Asian economies are maintaining pegs to the Dollar.

The consequence is that US goods become more competitive versus European, Canadian, and Austrailian goods while remaining uncompetitive with Chinese manufactures, while the appreciating currencies lose ground versus everybody. Meanwhile, anyone who holds dollars or dollar denominated securities is losing their shirt. The big foreign holders of such are the Gulf states, China, and Japan.

So what do you do if you have a trillion or three bucks worth of a depreciating asset? The temptation is to trade up to something with a more solid value, like the Euro, the Pound, or gold. Once the dollar selling starts, it's hard to stop, because each sale drives the value down.

So how can this unwind? The pessimistic, and increasingly probable scenario might go something like this: recession sets in Europe, inflation spikes in the US and China. The big state banks of the Gulf, Japan, and China stop lending the US enough money to keep our house of cards standing and world wide recession or worse ensues. On the bright side, CO2 emissions would likely drop.