Brad Setser has produced a “scary graph” showing the sudden stop of the inflow of foreign capital into the USA:
Paul Krugman asks “Is this the Wile E. Coyote moment?“:
So, according to the story, one of these days there will be a Wile E. Coyote moment for the dollar: the moment when the cartoon character, who has run off a cliff, looks down and realizes that he’s standing on thin air – and plunges. In this case, investors suddenly realize that Stein’s Law applies — “If something cannot go on forever, it will stop” – and they realize they need to get out of dollars, causing the currency to plunge. Maybe the dollar’s Wile E. Coyote moment has arrived – although, again, I’ve been wrong about this so far.
Krugman adds that the Saudis are rumoured to be about to diversify into euros. Certainly, if they had been buying euros instead of dollar for the last 5 years, they’d be a lot better off now, as this graph shows:
(You can get a dynamic version of this graph from Yahoo)
So it seems likely that governments, worried about the fall in value of their dollar holdings, will not buy dollars in future and will diversify their existing holdings into other currencies, particularly the euro. This reduction in the demand for dollars will in turn cause further drops in the value of the dollar, prompting those countries that haven’t already shifted their holdings out of it to do so. It seems likely that we are seeing the end of the dollar as the world’s reserve currency.