-- =DJ With Snow At Tsy Dollar Faces Lasting Twin Deficit Risks --
By Grainne McCarthy
Of DOW JONES NEWSWIRES
NEW YORK (Dow Jones)--The most immediate reaction in currency markets to John
Snow's nomination as Treasury Secretary has been a flurry of speculation on what
it might mean for the Bush administration's commitment to a strong dollar.
But while that question is certainly legitimate, traders could be focusing on
the wrong thing, particularly as Snow is unlikely to signal any departure from
the so-called strong dollar policy. The more lasting message from the railroad
executive's appointment arguably raises a greater risk for the dollar: a larger
federal budget deficit at a time when the current account deficit is also
widening.
To be sure, the designation of Snow to replace Paul O'Neill who was pushed out
of the Treasury top spot last week doesn't indicate a dramatic change in
President George W. Bush's economic policies - he had been planning tax cuts in
any case. But in designating a middle-of-the-road Republican with a reputation
as a manager and communicator, analysts believe Bush has hired a salesman to
guarantee a smoother path to getting his economic stimulus package approved.
"In the short-term, the question is whether the market sees pro-active
pro-growth policies as potentially dollar positive, but longer-term this means
moving deeper into twin deficit terrain, which is negative for the dollar," said
Alan Ruskin, research director at 4Cast financial consultancy in New York.
Indeed, the fallout from the shuffle of Bush's front line has resulted in a
familiar dichotomy between the short- and the long-term implications for the
dollar. Initially, investors are set to remain preoccupied with Snow's views on
the currency at least until he comes out and makes a statement either way on the
issue.
But longer term, the focus is set to shift to the effects for the Treasury
market as the government issues more debt to finance its budget, putting
downward pressure on Treasury prices. If global fixed-income investors should
shun Treasurys as a result, that could create another factor to hurt the dollar,
not least because global debt flows by far dwarf the equity flows that might be
generated from any such stimulus.
Then, there are the potential growth effects. While more fiscal stimulus -
coming on the heels of an extremely aggressive monetary policy - should inject a
dose of life into the still fairly sluggish U.S. economy, it stands to have a
more lasting effect on the current account, while driving a deeper hole in the
budget. "For the one-off stimulus you pay a continuous price," said Ruskin.
"It's playing to the Achilles heel of the U.S. economy, which is the external
balance being a problem."
Still Banging The Drum
The U.S. federal government posted a $53.99 billion budget deficit in October,
the first month of fiscal year 2003, up from the $7.66 billion deficit a year
earlier. For the fiscal year ending in September, the deficit widened to $159
billion, the first unified budget deficit since 1997 and a striking contrast
from the $127 billion surplus recorded in fiscal 2001.
At the same time, the current account deficit has widened to about 5% of gross
domestic product, a level that Federal Reserve economists believe leaves the
U.S. vulnerable to a sharp reversal. According to a Fed study, such a level has
historically been accompanied by a slowdown in growth and 40% nominal currency
depreciation.
To be sure, dollar bears have been banging this drum for years, to little
effect. In fact, from mid-1995 onwards, the dollar mostly powered ahead, even as
the current account deficit also leaped higher as foreign investors lined up in
record numbers to plow funds into the U.S. securities markets. Foreign companies
also went on a spending spree, buying up U.S. companies in the late 1990s'
merger and acquisition boom.
In that sense, the current account deficit almost didn't matter, particularly
as the federal budget was firmly in surplus. But the sands have shifted fairly
dramatically. In a turn in sentiment against the dollar this year, the unwieldy
current account has begun to weigh on the currency, rendering the prospect of a
larger budget deficit more of a clear and present danger now.
"If there's any color on this story, it's going to be as regards what the
market thinks will happen to fiscal policy," said Daragh Maher, an economist at
ING Financial Markets in London. "The twin deficits pose substantial risks."
Foreign investors - in particular Europeans - have been paring back their
investments in the U.S., while global fixed-income investors are seeking out
value in higher-yielding asset markets. While those investors were happy enough
to finance the U.S. capital expenditure boom of the late 1990s, economists
question whether they will be as disposed to finance the government,
particularly as they are now also faced with the element of currency risk.
"You're asking foreigners to finance public sector deficiencies rather than
high-tech led growth," said Ruskin. "It becomes a whole different equation."
Of course that's not to say that the dollar is in for a rapid slide - at least
not unless Snow were to shock markets by saying something extremely surprising
such as that he favors a weak dollar or that a strong dollar isn't in the
interests of the U.S. But it does point to more gradual downside for the
currency. And if that makes U.S. exports more competitive without destabilizing
financial markets, it is probably something the Treasury Department and its new
boss wouldn't object to.
-Grainne McCarthy; Dow Jones Newswires; 201 938 2381;
grainne.mccarthy@dowjones.com
(END) Dow Jones Newswires
12-10-02 1506ET- - 03 06 PM EST 12-10-02
10-Dec-2002 20:09:00 GMT
Source DJ - Dow Jones |
