How the Dollar Could Rally

The selling "reached a crescendo" Wednesday with General Motors' (GM) shocking profit warning, El-Erian continues, suggesting the automaker's bombshell "took the concerns [about corporate bonds] from a top-down technical sphere to a bottom-up credit sphere." (RealMoney.com contributor Tony Crescenzi also examined this development.)

Whether that selloff resumes remains to be seen; but with the Fed in a determined tightening mode, the domestic economy growing and oil prices surging, U.S. yields are rising. That, in turn, "fundamentally undermines the carry trade," El-Erian continues, referring to the widespread practice by speculators of borrowing cheap dollars and reinvesting them at higher yields overseas.

The carry trade has been the fuel for "aggressive moves" in the past two-plus years for (among others) the Brazilian real, South African rand and Turkish new lira, according to Greenwald. With U.S. rates rising, "it's not quite as easy to short dollars [and] I think you can expect a lot of that [money] to flow back" into the U.S., he says. Notably, the rand has been weak for much of 2005 and the real has fallen sharply in the past month. The carry trade has also fueled speculation in commodities that would be hurt if the dollar rallies, as (most likely) would the red-hot stocks of commodity producers.

Finally, there's that biggest emerging market of all: China.

Two weeks ago brought news that oil shipments to China fell 13% in January-February, raising concerns about a possible "hard landing" in that country. This week brought the sudden resignation of the head of the China Construction Bank, the nation's second largest, reviving concerns about the stability of the financial sector. Even unabashed China bull Donald Straszheim, of Straszheim Global Advisors, admits "trouble persists at China's troubled big-four state-owned banks -- stay away."

Furthermore, if there was pervasive accounting fraud in the Fortune 100, why not in China's emerging quasi-capitalist economy?

The point being that if/when China allows its currency to float or (more likely) widens the trading band, it may ultimately result in weakness -- rather than strength -- in the renminbi against the greenback.

That's very much a contrarian viewpoint but, then again, that's the point of this exercise.

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