Weekly Foreign Exchange Insights: August 21st
August 21, 2009
These are the hot, humid days of August, a time of erratic currency market activity but also a time for big picture thinking. The dollar lost ground this week. Recovery hopes continue to wax and wane with each new statistic, but optimism appears to prevail that negative global growth is ending, financial market conditions will get better, and chronic deflation can be avoided. Markets want to believe in a happy ending. The safe-haven factor, which supported the dollar and yen in late 2008 and early 2009, is fading, and the U.S. currency is relinquishing ground. If that were the extent of the dollar’s downside risk, the adjustment would be containable and short-lived. From some respects, dollar prospects might even be called bright. The U.S. current account deficit has been halved. Exports look competitive and are making a positive contribution to real economic growth. The United States still commands an enviable edge in productivity growth, and this should bestow a particular advantage after the Great Recession when it’s time to create, not just destroy. Compared to levels earlier this decade, the dollar look cheap. In light of the tendency of currency movements to overshoot, some shops argue that a prolonged dollar uptrend is now overdue. The U.S. has better demographics than Europe or Japan and doesn’t face near-term elections like Japan or Germany.
Alas, I’m not a fan of the dollar. It’s track record is too scarred to believe that a dollar reserve international monetary system will forever remain intact, and in the technology-charged 21st century, the future tends to arrive early. I’ve argued often that sooner or later, this system will be replaced, just like the abandoned pre-war gold standard and post-war system of fixed dollar parities. Only timing is in doubt. One of the 2001 Nobel economics prize winners, Joseph Stiglitz, expressed a variation of that view earlier today. Said he, the question is whether this process happens “in an orderly or disorderly way,” that is by political design or the force of market circumstances. An international reserve currency must offer the semblance of being a stable store of value. That’s a tall order for a currency that has seen 74% of its value against the yen eroded since 1971 and lost around 66% against the synthetic German mark. From highs early this decade, the dollar at 14:00 GMT today had lost 42.6% against the euro, 42.2% against the Swiss franc, 33.1% against the Canadian dollar, 30.7% against the yen and 17.4% against sterling. The dollar started 2009 on a firm footing thanks to the aforementioned flight-to-safety support, but the pattern of weakness has returned as documented in the following table. Period averages of the dollar against other currencies for 2Q09, July, August 1-20, and today are compared to first-quarter average levels and expressed as percentage changes.
| USD versus | 2Q09 | July | August 1-20 | August 21 |
| Euro | -4.2% | -7.4% | -8.4% | -9.0% |
| Yen | +4.0% | +0.9% | +1.8% | +0.1% |
| Sterling | -7.5% | -12.3% | -13.7% | -13.4% |
| Swissy | -3.0% | -6.0% | -6.7% | -8.0% |
| Cda-$ | -6.1% | -9.8% | -12.5% | -13.0% |
| Aus-$ | -12.6% | -17.5% | -20.3% | -20.4% |
| NZ-$ | -11.7% | -19.3% | -20.7% | -21.9% |
The dollar did not get much of a fillip in June despite sharply greater long-term net portfolio capital inflows to the United States. According to Treasury TIC statistics, the net long-term inflow ballooned to $90.7 billion from $21.9 billion on average in January-May and to $71.3 billion under a somewhat more inclusive compilation from a mean monthly deficit of $10.9 billion in the first five months of the year. When short-term portfolios are counted as well, however, the net flow was still in the red and, at $31.2 billion, similar to the average outflow of $36.2 billion in January-May. Looking ahead, a resumption of positive economic growth in the second half of 2009 is not likely to be associated with a sustained spike in risk aversion and the support such can give the dollar. Nor will U.S. interest rates offer a compelling appeal. Ten-year Treasury, bund, and gilt yields are tightly bunched with U.S. assets sandwiched in the middle. The Fed has pinned short-term U.S. market rates below 0.5%, and the onset of Fed tightening is not considered likely until 2H10, and probably later if Bernanke fails to get reappointed to a second term. The fact that uncertainty exists about the Chairman’s fate is itself a negative factor for the dollar, and so are Obama’s very public difficulties with both Democrats and Republicans in Congress, which have depressed his popularity among voters.
The dollar is not the only loser. One sees in the table that that dollar/yen is on a par but not above its first-quarter average and in fact has traded steadily over the past half year. Another currency that has been rock-steady against the dollar is the Chinese yuan. The yen’s circumstances could change after August 30 elections, when a new party will almost certainly take over the reins of power. The Democratic Party of Japan has proposed an irresponsibly expansionary fiscal policy but also seems inclined to adopt a greater hands-off approach to yen management. The LDP government had earned the respect of investors, who knowing that officials opposed a strong yen, never tested the 90 per dollar level even in the absence of currency intervention. The yen faces a period of great policy uncertainty with two-sided risks from Japanese factors. It most likely will take its cue from which way the dollar is blowing in general, that is correlate more positively with movements in the euro.
As for the yuan, Beijing officials have not signaled an intention to again disengage their currency from the dollar anytime soon. But they have clearly become uneasy that there economy is regaining steam too rapidly and could overheat. An effective way to te
mper Chinese growth would be to permit the yuan to rise. That would be a globally responsible gesture, but it will only happen as a result of internal debate, not foreign urging. That makes the timing hostage to a political decision and thus very uncertain. In the meantime, China will exert enormous influence over the dollar in general. As a huge holder of U.S. debt, China’s leadership has been at the forefront in voicing dissatisfaction with the U.S. dollar’s track record, urging Washington to show greater mindfulness regarding the dollar, and recommending that a new international monetary system be discussed, designed and implemented. U.S. data suggest that China may in fact be very discretely diversifying its portfolio toward non-dollar assets. It has been able to do this without creating disorderly market conditions that would harm its vested wealth.
The cosmic issues related to international monetary reform will be terribly important over a five-year horizon. Market participants heading into this autumn would like to know if the dollar is more likely to sink below 90 yen or recover beyond 100 yen. My answer is yes. Is the euro more likely to climb to a range of $1.45-1.50 range than to fall back to $1.30-1.35? I believe it is, but a third scenario of continuing drift between these two sets of extremes may turn out to be the path of least resistance in a marketplace that has been predisposed against following through on the prior day’s momentum.
Copyright Larry Greenberg 2009. All rights reserved. No secondary distribution without express permission.
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