Weekly Foreign Exchange Insights: February 6, 2009

February 6, 2009

The dollar retains a bid tone, trading more strongly than 90 yen, $1.3000 per euro, 1.15 Swiss francs, $0.70 per Ozzie dollar, $1.50 per pound, and $0.60 per kiwi.  Since end-2008, the dollar has climbed more than 10% against the kiwi and rand and is up by 8.5% against the Swiss franc and almost  8% against the euro.  Since November, the dollar has advanced over 25% against against the Russian and Belarus roubles, Kazakhstan tenge, Polish zloty and Ukrainian hryvnia, as well as at least 13% relative to the Czech koruna, Hungarian forint and Romanian leu. Among major currencies, sterling and the yen have best held their own against the dollar in 2009, ironically representing two of the hardest-hit economies.  Britain has experienced a very sharp steepening of its yield curve, while the yen continues to benefit from global risk aversion.

A two-day meeting of G-7 finance ministers and central bankers begins next Friday in Rome.  The gathering is unlikely to producer game-changing currency market news.  Although there is some dissatisfaction in Japan and Continental Europe about recent currency market developments, these officials have bigger issues to discuss.  They will review steps taken and being contemplated to grease financial markets and bolster sagging aggregate demand.  They ought to address the rise in protectionism, a tempting path that each nation has wandered down but which will harm all economies collectively if such behavior persists.  The goal sought by European leaders of less currency volatility is pretty much beyond their influence.  Tokyo officials have grown increasingly worried about the strengthening yen and have some limited permission from other governments to intervene unilaterally.  No intervention has occurred, however, because conditions are not right for conducting such an operation. With the financial crisis was spinning out of control when the last G-7 met on October 10th, the released statement abandoned the usual format including a paragraph devoted to on cooperative currency management.  The biggest market development since that time is neither the dollar’s 5.4% further rise against the euro or its 7.3% drop against the yen.  Nor are the moves in equities — amazingly only drops of 2.4% each in the Nikkei and DJIA and a 2.2% net rise of the DAX —  the ones that grabs most notice.  It is rather the more than 50% additional plunge of oil prices that best epitomizes the downwardly spiraling world economy during the past four months.

Without a policy initiative directed at the currency market, it probably would take an unexpected shock to shift the landscape.  I would not look to the economy to produce this. While officials keep emphasizing the extraordinary degree of uncertainty, the paradox is that rarely has the three-month prognosis for growth been so assured.  Activity will be contracting very sharply in North America, Europe and much of Asia including Japan.  Inflation will continue to ease, too.  Currencies over the rest of this quarter are likewise unlikely to take a new direction because of new policy stances, since such are becoming more expansionary everywhere.  Heavy deficit spending in the early 1980’s was associated with a significant rise of the dollar, but since very tight Fed policy was also pursued, that period is not a good guide for how the dollar will react this time, other than to suggest that the U.S. currency needn’t react adversely at first to rapid growth in national debt.  The pound’s rebound in recent weeks substantiates this point.

No well-founded reason exists to expect a major geopolitical disturbance.  The biggest surprise of the last 7-1/2 years is not that housing markets burst or even that such exerted wide-ranging damage to other parts of the world economy.  Rather it was the absence of an attack as big, or larger, than the 9-11 atrocities.  Not many people would have bet against a second such event back in the autumn of 2001.  As it is, the terrorists behind that crime were enormously successful in promoting the goal of dragging down the western world.  All the advanced economies are weaker now than then.  More importantly, long-term challenges to capitalist and democratic societies appear more daunting, since governments had no choice but to squander the pretense of budget discipline. The numbers of terrorist sympathizers has also swelled.  Dramatic terrorist surprises are intended to create chaos and fear.  What better time to play on such emotions than during the worst financial crisis in 80 years and the worst economy in at least a generation?  Currency markets have withstood the perils of dysfunctional banks, a deep and synchronized recession, and mounting economic nationalism.  The euro, for example, has allowed Europe to avoid the currency turbulence that repeatedly arose during difficult times in the past.  A geopolitical or natural disaster juxtaposed on these fragile times would likely kill the orderly behavior of G-7 currencies.  From the 9-11 attacks until 2001, the dollar rose about 9% against the yen but lost 1.3% against the euro.  The yen and euro responded differently then than now, proving that capital flight varies according to the triggering cause and surrounding context of the shock.

Copyright 2009 Larry Greenberg. All rights reserved.  No secondary distribution without express permission.


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