What is the dollar’s current currency paradigm?
* Growth Model. In the austere times of 2001, currency markets rewarded the dollar based on the Fed’s resilience and initiative to stimulate the US economy as seen through its aggressive interest rate cuts.
* Asset Market Model. After February 2002, markets hit the dollar based on the:
- Accounting malpractice triggered by Enronitis
- Eruption of violence in Middle East
- US imposition of steel tariffs heading off Trade War with Europe and Japan.
- Gradual muting of the strong dollar policy after O’Neill’s Trade hearing on May 1st
A Continued Dollar Slide is Ominous to the US and Rest of the World
* The advantages of a declining dollar to the US exports and the economy are dwarfed by the threats on the global economy resulting from appreciating currencies in the rest of the world.
* If the current slide in the dollar extends by another 5-8% before the end of the summer, currencies of export-dependent economies of Asia, Latin America and Western Europe will appreciate to the extent of creating a supply shock in these economies.
* The fact that the bulk of Q1 GDP growth in Germany and Japan stemmed from rising exports, suggests that additional strengthening in the euro and the yen could send these nations’ nascent recoveries back in the red. Exports made up 2.6% of Japan’s 5.7% rise in Q1 GDP while in exports in the Eurozone made up the lion’s share of the 1.0% GDP rise.
* This is especially crucial, given that the US imports about a fifth of the World’s exports.
The dollar’s current decline is all about the falling stock market, and is not merely due to the existence of the current account deficit.
* The swelling US trade gap, an overvalued US dollar, and more attractive stock valuations abroad have all been convenient explanations for a falling dollar. Yet, these very explanations were used since 1997, when economists were certain that the introduction of the euro would promptly destabilize the US dollar from its pedestal. Instead, the US trade deficit worsened from -2.5% of GDP in 1998 to nearly -4.5% of GDP in 2001, while the dollar ascended to 15-year highs. Thus, the existence of the current account deficit in and of itself is not the catalyst to the falling dollar, but the damage in Wall St.
* The current equity sell-off is unlike any other sell-off in the past. It is a result of an unprecedented combination of corporate distress, accounting malpractice, investment banking impropriety, corporate governance and geopolitical concerns. Hence, US stocks are not only hit by terrorists from far away nations, but also by the Chiefs of America's new favorite past-time--stock investing.
What about the Fed’s Latent Concern with the Falling Dollar?
* According to the minutes of the May 7 FOMC meeting, the Fed referred to emerging inflation concerns stemming from various sources including the falling dollar. By the May 7th meeting, the Fed’s broad dollar’s trade-weighted index had fallen 1.4% from its late January high. Today, the Index is down more than 3%, from its January high.
* Thus, if the Fed were concerned when the dollar was off 1.4%, it is definitely more preoccupied with the dollar’s accumulated losses doubling thereafter.
* The Fed's willingness to participate in the June 28 coordinated central bank intervention to cap the rising yen, is also a tacit endorsement to stabilize the falling dollar.
* The June 28th intervention reflects the increased preoccupation by global monetary authorities with the fall in the world’s reserve currency—the dollar, which still accounts for 74% of the FX armory of industrialized nations’ central banks, compared to 13% for the euro.
* Thus, it is nonviable for these cenbanks to let a decline in the currency go unchecked. Asian central banks are particular owners and “buyers” of dollars.
The dollar cannot go on ignoring superior US growth relative to the rest of G7 nations, and should start stabilize as the “growth” priority re-emerges once US stocks ease their decline.
* US GDP growth is expected at 2% in Q2 and 4% in Q3. The Eurozone and Japan are seen at 2.0% and 2.5%, and –1.0% and 1.0%. UK growth is seen at 1.5% and 2.0%.
While there is indeed a slowdown in the rate of foreign financing of US current account deficit, the flows funds into US bonds—the primary beneficiary of foreign investments-- may steady as the Fed is increasingly expected to delay raising interest rates into 2003.
* In the first 4 months of this year, net flows into corporate bonds totaled $66.3 billion compared to $91.8 billion in the first 4 months of 2001. But it’s still higher than in the first 4 months of 2000, 1999 and 1998. That’s not in the case of US stocks.
-July 17 |
