It Won’t Be Only About Greece

January 15, 2010

Dollar movement in the second week of 2010 remained choppy.  Net changes against other major traded currencies were mostly minor including a 0.3% uptick against the euro as of 17:50 GMT on Friday.  The exceptions involved drops of 1.5% against sterling and 2.1% relative to the yen.  A quite different and more pessimistic impression about Europe’s common currency was reflected in wire service chatter and the behavior of the euro’s cross rates against key non-dollar currencies.  The Greek debt crisis and ECB President Trichet’s drop-dead message of not cutting the Greek government any policy slack had investors speculating about a break-up of the European currency union in serious ways reminiscent of the experiment’s early days of 1999 and 2000.  At its recent lows, the euro had declined 2.7% against sterling since December 30, 2.7% against the Swiss franc since December 14, and 3.1% against the yen over the past four trading sessions.

The euro is the dollar’s likeliest challenger for currency portfolio hegemony and all the intrinsic benefits that role bestows.  So the elevated concern about the euro naturally fortified confidence that the U.S. currency will retain dominance among reserve currencies.  The fact is the dollar’s share of reserve asset portfolios has not really been dented since the creation of the euro and still runs above 60%.  When U.S. officials talk about seeking to preserve a strong dollar, their meaning is directed at the dollar’s acceptance by major reserve asset portfolio holders, but it is not necessary in meeting that goal for the dollar to appreciate or even hold steady against other currencies over the long run.  The semblance of two-way dollar risk in the short run will suffice, so we see the paradox of the dollar not getting seriously challenged as a reserve currency yet trending lower against traditional hard currencies.

  • The dollar recorded peak levels against the yen of roughly 360 during the 1970s, 280 in the 1980s, 160 in the 1990s, 135 last decade, and 93.76 this month.
  • The dollar’s highs against the D-mark were seen at DEM 3.65 in the 1970s, 3.48 in the 1980s, 1.96 in the 1990s, and 2.38 last decade.  The last two of those figures represent DM-translation values reached within the first two years of the euro era calculated at a parity of one euro to DEM 1.9558.
  • The synthetic mark averaged 1.699 per dollar last decade, 40% stronger than its October 2000 low.
  • The strongest D-mark/dollar quote in the entire pre-euro era was 1.345 per dollar on March 8, 1995.  The DEM-translation value of the euro is presently 1.355, just a single pfennig or 0.7% from its best level ever prior to 1999.  The dollar is now over 20% weaker than the DEM equivalent level that provoked a major dollar rescue package and the Fed’s adoption of a monetarist policy framework in the late 1970s.

Everything is relative.  The dollar is 11.5% stronger than its July 2008 low against the euro, but it lies in the lowest portion of its entire post-World War 2 range of movement.

The currency market spotlight is unlikely to remain on Greece in a sustaining way.  At the ECB press conference, Trichet observed that California’s share of U.S. GDP is some four times greater than Greece’s share of the European Monetary Union’s gross domestic product.  California, like Greece, is in very dire fiscal straits but of course is not a sovereign nation with any presumption of being underwritten by the Federal government.  Trichet’s analogy should not be totally dismissed, nonetheless, because of California’s bellwether role in the United States.  Many U.S. developments start early in California.  The main reason to be less bearish about fiscal trends in the United States than Europe is America’s better rate of population growth, but there is ample reason for concern about the future ability to service government debt on both sides of the Atlantic, and of course Japan, too.  Fiscal differences are not great enough for this factor to be a game changer for the currency markets in 2010.

Currencies tend to be influenced more keenly by monetary policy than fiscal policy, as indeed they should.  Exchange rates are the prices of national monies against one another, and central banks exert considerable control over supply.  It’s seldom good for a currency when the politicians are taking pot shots at monetary policymakers as one sees lately in the United States.  Investors know better than to place any faith in Congress to manage fiscal matters prudently.  Why would politicians run monetary policy any more responsibly than an independent central bank?  It’s a well-documented fact that price stability is a more attainable goal where central banks are granted a lot of independence, and the change in Great Britain before and after 1996 is a great example of this.  What, then, is to be made of the start of 2010 and whether certain currencies are favored?

The main development has been the widening gulf between advanced G-7 economies and emerging markets especially in Asia.  The United States, Europe, and Japan each reported more weaker-than-expected than stronger-than-expected economic data, and there were some really big clunkers in the mix, like the 11.3% plunge in Japanese machinery orders, a 5.0% drop last year in German GDP, and reported declines in both U.S. retail sales and industrial production when increases had been anticipated.  A few more weeks like the past one, and financial markets might feel like its early 2009 again.  Unlike then, emerging market are back in high gear, especially China.  This divergence from the perfect storm for a stampede into safe Treasury bonds has several implications.

One concerns the Chinese renminbi, otherwise known as the yuan.  Chinese officials are likely to engineer its resumed appreciation sooner than seemed possible at the end of December.  China and other Asian countries will also see their short-term interest rates raised.  Like before, China retains sufficient capital controls to make sure that the exchange rate does not appreciate rapidly.  The pace of the yuan’s climb is unlikely to boost the yen much.  In fact, Japan’s economy is in really bad shape, and political stability has unraveled at the edges.  The yen ought to be falling, and if orthodox economic fundamentals were all that determined currency values, this would be happening.  Instead, the yen was this past week’s biggest winner.

Currency traders move in herds, and many are concluding that the place to put money is into commodity-sensitive currencies, especially since lost ground between highs early in the financial crisis and subsequent lows in 2009 has not been recovered fully.  The Canadian dollar had fallen from 0.9061 per U.S. dollar to 1.3064 and has so far recouped just 69.4% of that loss.  The kiwi’s recovery of its drop from US$ 0.8213 to US$ 0.4896 is 74.8% completed, and the Australian dollar has reversed an even larger 83% of its prior plunge from US$ 0.9848 to US$ 0.6250.  These currencies got slammed by the brunt of the world recession because emerging markets were not immune in that round.  They have been spared this time because macroeconomic policies remain very loose in emerging markets, so demand for commodities and the prices of such shouldn’t collapse.  Oil closed on January 15, 2008 at $35.40 per barrel, 54.5% lower than now, and many other commodities have recorded even sharper on-year advances.

The uncertainty surrounding other currency relationships is underscored by the dollar’s atypical pattern of movement around the cusp between 2009 and 2010.  In the first ten years of the euro’s existence, the dollar fell eight times against the euro during the second half of December and by 1.3% on average.  Over the 36 years to 2008, the U.S. currency had risen just ten times against the mark and on balance lost 1.0% between December 15 and 31.  But during that period in 2009, the greenback rose 1.5% against the euro.  Just as there is a dollar bias toward weakness in late December, there is a tendency for the currency to rise against Europe’s main currency in the first half of January, but that pattern also failed to occur this time.  Since the euro’s birth, the dollar had posted an average advance of 0.8% by mid-January.  Among the 34 years to 2009, it rose 24 times and by 1.2% on average against the mark.  As noon approached in New York today, the dollar was showing a 0.5% drop against the euro and declines since December 31 of 2.7% against the Australian dollar, 2.5% relative to the yen, 1.9% against the Canadian dollar, 1.5% against the kiwi, 0.8% against the Swiss franc, and 0.6% against the pound.  Yet again, cup half-full talk about the dollar is belied by a cup half-empty performance.

Copyright Larry Greenberg 2010.  All rights reserved.  No secondary distribution without express permission.

Tags: , , ,


Comments are closed.