Blast from the Past with Lessons for the Present and Future

July 20, 2014

I’ve accumulated way too much paper stuff in my four decades as a currency market watcher and, out of necessity, find myself culling files on a lot of weekends.  This is generally tedious work, but every once in a while I find something I wrote that represents a career milestone as I did today.  It’s the last Foreign Exchange Briefs weekly essay that I wrote for the Ried Thunberg from 1989 until the international and foreign exchange portion of that investment advisory firm ended in 2008 (the U.S. domestic part of the service closed shop four years later).  This particular issue of Foreign Exchange Briefs was written on April 25, 2008, less than two months after the bail-out of Bear Stearns, several months after the onset of a recession, but before the Lehman Brothers fiasco and the renaming of what is known now as the Great Recession.  The dollar at the time was worth 1.5630 per euro, 1.9852 per pound, JPY 104.4, and C$ 1.0143.

The essay does not foreshadow the immense deterioration in the U.S. and global economy that was to follow, speaks of an investor mood of rising hope and expresses doubt about the prevailing conventional wisdom anticipating a strengthening dollar.  Reading something like this over six years afterward is sobering but instructive of how little of the future can be correctly foretold by experts from the financial community and academia based on current conditions.  I think the article is also of contemporary interest because the issues that surfaced in 2008 are still very influential in 2014.

Here then is what I wrote:

The dollar has been enjoying a respite.  The buck’s rise is part of a wider reversal of market trends that has seen equities recover too but bond prices and commodities lose ground.  From a broad standpoint, the dollar remains weak, trading 10.3% lower than a year ago on a trade-weighted basis, while the euro, yen and Canadian dollar are 8.7%, 8.0%, and 7.2% higher in such terms.  Compared to six years ago, the dollar has depreciated 38.7%, and the euro and Canadian dollar are 33.5% and 42.5% stronger. The trade-weighted yen, like the dollar, is softer than six years ago, albeit by just 2.9%.

The better dollar performance can be traced to some concrete developments. G7 finance ministers and central bankers sharpened their protest against recent foreign exchange developments and followed up their joint statement of April 11th with admonitions that investors were ignoring the new forex policy language at their own peril in bidding EUR/USD up to a new high. The Fed’s facilitating role in bailing out Bear Stearns demonstrated that big financial institutions are too entangled to allow even second-tier players to fail.  Raw investor fear subsided in response, and carry trading returned though not at the frenzied pace of its heyday.  Carry trading diminishes the dollar centricity of currency trading and on balance lends the greenback some support.  U.S. tax rebates will soon be in the mail, and Fed officials have signaled an intention to pause monetary easing, perhaps for good depending on how the U.S. economy and markets respond to previous actions.  Evidence of slower growth have surfaced in Britain, Euroland, Japan, Canada, Australia, New Zealand, and several emerging economies.

But much has not happened to halt dollar depreciation in an enduring way. G7 officials did not call for the dollar to strengthen.   Post-communique complaints came in reaction to new dollar losses.  No currency intervention has been undertaken.  ECB officials continue to resist any suggestion that they cut rates, and expectations that the BOJ would halve its 0.5% rate target have given way to a new structure of market rates that prices a rate hike  later in 2008 as more than a two-to-one likelihood.  The U.S. housing market isn’t stabilizing. Until it does, any talk of a turn for the better in the U.S. economy or global credit crunch is speculative optimism.  Fed officials exhibit no inclination to raise rates to counter inflation or support the dollar with the U.S. economy as weak as it is. That is what some giants from the academic world like Stanford professor Ronald McKinnon have suggested, and their advice continues to fall on deaf Fed ears.

The basis of Treasury Secretary Paulson’s prediction of a dollar comeback does not inspire confidence. The dollar will rise because the U.S. has good long-term fundamentals, he asserts without explaining what he means. U.S. inflation is not relatively low. It’s current account is in chronic deficit. Real short-term interest rates are low.  The cost of war in the Middle East exacts an enormous continuing toll on limited resources.  Americans widely think the country is on the wrong track.  There is no strategy to reduce dependency on imported oil.  Public education is failing, and college costs are increasingly unaffordable.  Politicians are following the siren song of protectionism.  Record budget deficits are back. Productivity has slowed. Since the 1960’s, the long-term dollar trend has been down, not up.

Copyright 2014, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.


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