The Robust Dollar Could Cause Problems
By William Pesek Jr.
Exchanging dollars in Zurich recently, I encountered a number of animated Europeans who were
bound for America and not particularly happy about it. The travelers were plenty excited about the
trip to New York but miffed about the measly pile of greenbacks they received in return for their
Swiss francs and deutschemarks.
"With the euro falling and falling and falling, traveling is becoming less affordable and possible,"
complained Ola Richter, a 36-year-old Zurich-based house painter. Sara Hartung, a 29-year-old
architect from Berlin, added: "This new currency of ours seems to have no bottom to it."
Bottomless, indeed. The euro last week established another all-time low versus the dollar, something
that's become so common that traders and journalists seem unfazed by each new landmark level. At
the same time, however, folks increasingly are paying attention to the stubbornly robust U.S.
currency. The reason is growing recognition that the dollar's strengthening trend has gone about as
far as it can without causing major problems in the U.S. and global economies. Also causing
nail-biting is what a sudden dollar reversal would mean for markets and economic stability from
New York to Sydney.
In Europe, the party line is that the euro is not
weak so much as the dollar is strong. If only the
U.S. would stop hogging all the world's capital,
the thinking goes, the euro would suddenly leap
into the stratosphere. But in reality, the euro's
quandary is a symptom of Europe's failure to
make its economies more competitive and the
European Central Bank's poor track record of
creating confidence in the currency. The ECB's
inability to even mention the euro without
sending it into a tailspin isn't helping. Neither is
speculation in markets that ECB President Wim
Duisenberg may soon resign.
The euro last week slid below 83 cents for the
first time in its 22-month existence. It stabilized
Friday -- ending the day at 83.80 cents -- but the
currency continues to inflict pain left and right.
It's raising inflation risks in Europe and forcing
the ECB into rate hikes that eventually could
slam economic growth, warns Ashraf Laidi, a
director at MG Financial Group. And investors
who've bought the currency are losing big.
But it's hard to ignore the fact that the dollar's strength is becoming a problem as well. Corporate
America is increasingly feeling the pain, not only from the dollar's strength -- which makes U.S.
exports less competitive -- but from the soft euro. U.S. companies with European operations are
seeing profits dwindle as they're translated back into dollars.
The bigger problem, however, is the effect the greenback is having on other currencies. The euro
may be grabbing the headlines, but it's hardly the only currency on the defensive nowadays. The
South African rand recently hit a record low against the greenback, as did the Philippine peso. The
Thai baht reached a 28-month low versus the dollar, returning to levels seen during the Asian
financial crisis. Singapore's dollar also plunged, as did the Brazilian real and the Chilean peso.
Brady bonds have gotten creamed. Finally, the Korean won is at its lowest level in six months.
Recent volatility has some wondering whether a new emerging-market crisis is afoot. So far, notes
David Gilmore of Foreign Exchange Analytics, there are few telltale signs of the kinds of contagion
that infected markets in 1997 and 1998. Yet the burn rate of many emerging-market currencies --
which can be attributed to a combination of slowing U.S. growth, volatility on Wall Street, surging
world oil prices and rising tensions in the Middle East -- deserves attention. Adds Gilmore:
"Contagion is ... bubbling up through the cracks." This isn't the U.S. dollar's fault directly.
Investors scouring the globe for attractive returns are ending up in the U.S. of their own accord.
And who could blame them? The economy slowed to a 2.7% annual growth rate in the third quarter,
but it remains strong, while inflation hasn't become a problem, as evidenced by the tame 0.9% rise
in employment costs in the third quarter. And the U.S. stock market remains one of the greatest
shows on earth.
Yet there comes a point where the dollar's advance ceases to benefit anyone and takes a greater
share of global capital than it deserves. In Washington, there's much soul-searching about whether
the dollar already has reached that point and what to do about it. Ray Dalio of Bridgewater
Associates notes that the current squeeze on global dollar liquidity is similar to ones that involved
the yen in 1994 and '95 and a variety of emerging-market currencies in 1997 and '98. The current
squeeze is driving up the dollar and hurting stock markets everywhere.
The problem, Dalio notes, is that there's a
shortage of dollar-denominated assets outside
the U.S. and a surplus of liquidity in the U.S.,
which explains the Federal Reserve's reluctance
to cut interest rates. Comments by Fed officials
suggesting that a rate cut isn't even on the radar
screen disappointed the bond market last week.
High-yield bond rates continued to rise amid
concerns over credit quality, while Treasury rates
edged slightly higher. The yield on the 10-year
note rose to 5.70% from 5.64% a week earlier.
The two-year note rate ended the week at 5.91%,
up from 5.83%.
Yet Friday's powerful rally in bank stocks may
suggest that recent concerns about a credit
crunch in the U.S. are overdone. And with the
U.S. growing half as fast in the third quarter as it
did in the previous two, there's growing
optimism that the Fed's next move will be cut
rates, maybe as early as 2001's first quarter.
In the past, such imbalances were resolved when
the squeezes became too severe, triggering plunges in stock prices, a sharp widening of credit
spreads and easings by central banks. Indeed, this sort of crisis might be reemerging because the
dollar is causing tensions in economies that compete for liquidity, carry a considerable amount of
dollar-denominated debt and are big net importers of oil. And economic problems that pose
systemic risk to the global economy will only exacerbate and spread that process.
Argentina, for example, is on the brink of crisis
and other key emerging economies like Brazil
and Korea also are getting lots of attention from
investors and global policymakers these days. In
Argentina's case, not only is the nation plagued
with a stubborn recession and political
instability, but its economic competitiveness is
pegged to the strong U.S. dollar. It has a sizable
amount of dollar-denominated debt, much of it
due in the year ahead. "Argentina's
fixed-exchange-rate regime leaves them, as well
as their trading partners, vulnerable to financial
crisis," notes Gregory Thomas Weldon,
publisher of Weldon's Money Monitor, a daily
investment letter.
If Argentina goes, Brazil could get dragged in as
well. Latin America's biggest economy has a
current-account deficit that's over 5% of GDP.
Problems in Argentina would make money
harder to come by in the region, complicating
Brazil's ability to finance its trade gap. Even the
Mexican peso has been affected by Argentina's woes. Korea's in better shape but with major trading
partners like Japan limping along, regional currencies swooning and oil costs up sharply, its
economy bears watching.
If the dollar doesn't cool off on its own versus the euro and yen, investors may take the driver's seat.
It's rarely spoken of in Washington or New York, but the U.S. and Europe may pose the biggest
risks to the global financial system. If the stock market cracks or capital flees the U.S., it may take
not just the Fed, but the International Monetary Fund as well to save the day.
Conversations with bankers and policy makers attending the annual IMF Fund confab in Prague
last month made these risks abundantly clear. Even with oil prices surging, the euro crashing and
protesters tossing cobblestones their way, trends -- and risks -- in the U.S. economy were part of
every discussion. It's for that reason many think the next global crisis will come from a giant,
industrialized country, not a developing one. It's not surprising, then, that the rest of the world is
watching the U.S. and the eurozone with a mix of wonder and fear.
From Barron's |
