Dollar Resumes Fall

The dollar resumed its recent fall, as Bloomberg reports the biggest two-day drop since 2001. This is not surprising, given the Fed's recent decision to buy MBS from Bear Stearns, and begin selling Treasuries.

Also, some thoughts about the Euro. I've been rethinking my position on the Euro.
The main problem with the Euro is that the ECB has power over interest rates and monetary policy (amount of reserves vs. Euro's). Unlike the Fed or the BofE, however, the ECB does not have regulatory oversight over the banks it lends to. This is a national issue. Also, while the Fed and the BofE attempt to balance inflation with employment, the ECB is only concerned with targeting inflation.

I was seeing an inherent and possibly fatal internal conflict in the ECB's job. On the one hand, it is beholden to Germany to keep inflation down, and interest rates up. On the other, it can ignore the economic malaise that will result from Spain and Greece's property bubbles imploding. Another cause for concern is the recent weakening of Italian bonds, with the resulting jump in interest rates. The Italian government cannot be very happy about having to pay higher interest rates because inflation is a little too high in Germany. If interest rates widen enough, then the EU could fall apart. (Now that I'm putting my thoughts on paper, I'm thinking that if any weaker players dropped out, then that would support the Euro, not devalue it.)

A second problem is that there is no lender of last resort. The ECB is not set up to bail anyone out. So, my thinking was that if there was a major bank collapse such as Northern Rock or Bear Stearns, the ECB would be in trouble. So, it would avoid any question of its authority by flooding the market with liquidity, which it has. Most of this has been temporary. If a major crisis came up, either there would be a systemic collapse from the bank's inability to do anything, or they would find a way to engineer a bailout that would upset the other nations who would threaten to leave if the strain grew too much. However, if they really have no authority to bail anyone out, then the Euro really is stronger than I thought. If there is a crisis, any required bailouts would be modeled on the German state banks, whose losses were paid for by the local governments, not by the ECB.

I'd love to short the Pound vs. the Euro right here, but FXB is overshorted already. I'm going to look for a chance to buy the Euro. I really want to move to a 50% anti US dollar position over the next few weeks. Right now, the options account is good with a position in gold, and long US Treasuries, for the deflation play. On the equity side, I have a small position in gold via OZN, commodities via PWE and IPSU, and foreign equities via PWE, and foreign currency via Yen. I also have FXP (Ultrashort FXI, the Shanghai 25 index), which is indirectly an anti-dollar play. As the dollar goes down, there will be inflationary pricing pressure on China, because of the loose peg to the dollar. As the Chinese government tries to fight inflation, they will choke off the credit that has juiced the stock and property bubbles.
All these holdings together amount to 23% of my equity positions. I think I should double them over the next month or so.