Weekly Foreign Exchange Insights: March 6th

March 6, 2009

The dollar experienced another good week until the labor data-inspired blow-off on Friday.  New 2009 highs were set against the euro, yen, Canadian dollar, and kiwi earlier in the week.  The back-drop remains the same, namely very intense recessions just about everywhere and plunging equities and real estate in a climate of extreme risk aversion.  Dollar resilience ought to reappear rather quickly.

It seems premature to think the U.S. and global recessions are near an inflection point. At 17:00 GMT today, equity markets were showing similar nominal declines since the end of 2008 to those that had accrued between the failure of Lehman Brothers in September and end-2008.  Since the earlier period was 70% longer than the more recent one, stock market trauma has in fact intensified substantially.  The DOW is on the brink of passing back through its level when former Fed Chairman spoke of irrational exuberance in December 1996.  Labor market weakness — comprising trends in unemployment, hours worked, job security and incomes — is more profoundly disturbing now than in 2008.  Changes in wealth and income affect spending with a lag, so the contention that the worst two quarters will be the last and present ones seems hopeful but not all that compelling.

% Change DJIA Nikkei Ftse Dax
9/12/08 -12/31/08 -23.2% -27.5% -18.1% -22.9%
Since 12/31/08 -25.0% -19.0% -20.4% -23.8%


Aside from a 16% drop against the yen between the Lehman collapse and end-2008, the dollar performed well in both periods.  It has continued to rise against commodity-sensitive currencies even though oil, which tumbled 55.6% in the former period, has been stable this year.  The dollar has also broken free of its historic inverse relationship to gold.  Gold advanced 15.2% on net in the earlier period and another 6.6% so far this year.  While commercial demand for gold has dropped sharply, investors recall that gold was about the only asset to perform well in the 1930’s and are wondering if lightning might strike twice.

Dollar versus Yen EUR C$ A$ NZ$
9/12/08-12/31 -16.0% +1.8% +14.6% +15.7% +14.5%
Since 12/31/08 +6.5% +9.6% +4.9% +10.0% +14.1%


Precedent plays an important role in framing a currency forecast.  When officials stress the high level of uncertainty, one of their messages is that because the global economy is in uncharted waters, it is difficult to glean useful guidance about the future from past circumstances.  Perhaps the best precedent is Japan’s lost decade, because the trigger for that economic accident was also an unworkable banking system, and it too was accompanied by massive losses in asset wealth.  The analogy breaks down somewhat because Japan was one economy in crisis, whereas a world recession is happening now.  Also, Japan had a balance of payments surplus, and the United States runs chronic deficits.  But the United States is in the unique position of borrowing capital in its own currency, so the surplus/deficit distinction is less meaningful that it appears at first glance.  And since the present crisis began as a U.S. financial crisis and prompted significant policy reactions by U.S. officials before the responses of other governments, the United States finds itself now in a similar role to Japan in the early 1990’s.  One other similarity is that U.S. public finances will deteriorate very rapidly just as Japan’s did in the 1990’s, and another difference is that the Fed’s target rate fell below 0.5% within 18 months of the onset of the crisis, whereas it took nearly six years for Japan to reach that point in September 1995.  Between the end of 1989 and April 1995, the yen rose 80% against the dollar from 144 per dollar to 80 per dollar, and the Nikkei fell 58%.

Flexible, market-determined exchange rates do a pretty good job of clearing the demand for and supply of national monies against one another, but they do not necessarily promote a reduction of global imbalances or foster the widest good for the most people.  Japan had the weakest economic growth of anybody in the early 1990’s, low and falling interest rates, and in fact had a pre-deflationary condition.  Yen appreciation amplified Japan’s economic weakness without weaning the economy from its over-reliance on foreign demand to generate growth.  Falling import prices caused by the rising yen expedited the economy’s descent into deflation. As we move deeper into this crisis, don’t be surprise to hear calls for reinstating fixed dollar exchange rates.

Neither the United States nor the world economy are being served well by a rising dollar.  At its most basic level, the world is in an economic crisis because of wide disparities between habits of savings and investment.  A U.S. shift toward more savings and export-led growth will need to be a central part of the long-term global economic fix and a prerequisite for breaking away from pattern of more frequent and increasingly intense economic and financial crises of the past 25 years.  A rising dollar impedes that adjustment.

The potential for social upheaval caused by this crisis is climbing.  It doesn’t help that many legislative bodies are unable to act.  Japan’s legislature has been especially stalemated.  U.S. politics remain as polarized as ever, discrediting a major promise of the Obama campaign.  A new paradigm of bipartisan politics to solve problems that all Americans share and to put that same preference for cooperation over competition into foreign policy conduct had been the way Obama successfully differentiated his vision from all others.  Reality has proven very different, and Republican opponents have framed Obama’s domestic agenda and budget as being even more partisan than President Bush’s was.  Most worrisome has been the accusation that Obama’s is a socialist agenda.  “Socialist” is a loaded word, which can whip up and misdirect collective behavior.  A tragedy of the worldwide depression in the 1930’s was a backlash against ineffectual, fractious and, in certain cases, socialist governments that beget fascism and the Second World War.  May
mankind find a peaceful solution to today’s vexing economic problems and not one that repeats mistakes from the past.

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


Comments are closed.