[MownySue]

Before we look ahead, we need to look back – and specifically at the 2001-2005 period, which has many similarities with 2007-2011. While the 2001/2002 crisis – involving 9/11 and the Nasdaq bubble bursting – was much less of a shock than the global credit crisis, it was still a US-centric event, which thereafter spread around the global economy. As such, it has important lessons for how the USD may trade into the 2010s.

2002-2004: Global money supply booms and the USD declines
Over the last decade there has been a clear connection between global money supply growth and the USD. Global M2 growth rallied from Q4-2000 to Q2-2003. The key driver was a massive rally in especially Eurozone M2 growth as US money supply contracted in this period after the burst of the dot-com bubble. The rally in global money supply eventually led to the massive weakness of the DXY from 2002-2004 – there is a lag time, but eventually the supply of USD told on the value of the currency.

2005: A temporary USD rally
Thereafter, global money supply growth contracted from Q2-2003 to Q4-2005 as the Fed began its tightening campaign and China tightened its monetary and credit policy. Here too, there was a lag between the reduction in money supply growth and the temporary rebound in the value of the USD in 2005, which was also helped by the US Homeland Investment Act, encouraging US corporations to repatriate foreign earnings with the use of tax deductions.

2006-Q2/2008: Renewed USD weakness as global money supply growth booms again
From Q1-2006 to Q1-2008, global money supply boomed once more as the Fed's tightening campaign came to an end and was reversed due to massive monetary easing whereas M2 growth in the Eurozone continued to rally. This was clearly a key driving force behind the renewed multi-year weakness of the DXY.

July 2008-February 2009: A temporary USD rally
From Q2-2008 until February 2009, global money supply growth contracted viciously as the twin housing and credit bubbles burst. This contraction in global money supply growth, coupled with the need to repay USD debt as a result of de-leveraging were key drivers of the USD strength in to Q1-2009.

March 2009-?: Renewed USD weakness as global money supply growth booms again
Global money supply, proxied by the sum of US, Euro area and China money supply bottomed in February, but has since rebounded, led by China. Going forward, global money supply should rise further as major central banks will be cautious in taking back excess liquidity. The pattern is clear. There are leads and lags and they vary – and are shown clearly via appropriate quantitative analysis. However, the key focus is the trend – and that is lower for the USD so long as global money supply growth is increasing.

In response to the bursting of the twin bubbles, the world's central banks have responded vigorously by slashing interest rates. Moreover, those of the US, UK, Switzerland and Japan have now adopted some form of quantitative monetary easing – increasing the money supply via purchases of securities. In addition, governments have adopted enormous fiscal easing measures, in many cases helping to support their own banking systems. Major central banks such as the Federal Reserve and Bank of England (BoE) will be cautious in withdrawing liquidity from the market and raising interest rates. Analysts do not expect the Fed, ECB and BoE to raise interest rates before 2011. Meanwhile, analysts expect the large economies to remain committed to maintain simulative policies for the foreseeable future as highlighted in the G20 Communiqué.

At the time when the bubbles burst, US bank debt/GDP was at its highest level on record, as was US consumer debt. It will take years rather than months to repair shattered balance sheets. However, money supply growth is already showing signs of picking up again, both at the national and the global level – and that means we are likely to see the USD give ground once more. Such increases in money supply are multi-year events- as will be the USD's decline. The bigger question is how far and how fast will it fall?