With Goldman Sachs (ticker: GS) being sued by the Securities and Exchange Commission (SEC) for fraud over subprime CDO’s gone bad, the potential is there to see a measure of risk taken off the table the table over the next few days.

And as we’ve seen, when risk comes off the dollar gets bought.

We certainly saw that on Friday as the greenback advanced against the better-yielding euro, pound, Australian and New Zealand dollars while the S&P declined by 1.6%. Meanwhile, GS lost over $10 billion of market cap and financial shares declined an aggregate 3.8%. As always, commodities like oil fell and Treasuries advanced while traders grew more skittish.

Going forward, there’s now an element of uncertainty which didn’t exist prior to the disclosure. For one thing, it’s doubtful that this particular transaction was the only one of its kind that Goldman was involved with. Indeed, the British and German governments gave early indications that they plan to do a bit of digging themselves, and we already know that Goldman helped Greece hid the extent of its deficits with interest rate and currency swaps.

As a trader, it’s always important to look at what happened to the markets under similar circumstances. The problem here is that basically, as far as I can tell, no one has ever traded through an SEC fraud allegation of one of the world’s biggest investment banks while the global economy is at the early stages of recovering from a devastating credit crisis.

That’s why a simplification of the situation sometimes the best approach. To my way of thinking, if it looks like garbage and it smells like garbage then it must be garbage, which means that we’re likely to see a continuation of what happened last Friday at least over the next few days.

The problems related to GS aren’t the only ones which could cause stocks to take a tumble (and cause the dollar to advance). For one, China is making some moves to pressure its growing real estate bubble by requiring higher down payments and limiting loan amounts for non owner-occupied homes and apartments. Prices in the big city coastal areas are already several multiples above what even a two income household can afford to carry.

Still, in the longer term, there’s every reason to believe that investors will go long once they spot a bargain. It’s highly unlikely that Goldman is going to come out of this with anything more than a few bruises and some blows to its pride. People are not going to permanently stop doing business with them.  It does look bad now, and it is, but Goldman is not going out of business and the banking system is not going to seize up as it did after Lehman collapsed.

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