Dollar's Drop May Spoil Street's Mood
Sunday May 25, 3:00 pm ET
By Pierre Belec
(Pierre Belec is a free-lance journalist. Any opinions expressed are those of Mr. Belec.)
NEW YORK (Reuters) - Just when you thought it was safe to get back into stocks, Washington finds a new weapon of mass destruction -- a bunker-busting policy change for the dollar.
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Much of Wall Street's outlook hangs on the dollar's prospects. Proof: Stocks suffered their biggest loss in almost two months on Monday after Treasury Secretary John Snow suggested over the weekend the United States had abandoned its eight-year policy of using rhetoric to support the dollar.
Stakes are high. A free-falling dollar could trigger an exodus of foreigners from American markets. The Street may no longer be the investment "hot spot" if foreign money shifts to regions with stronger currencies and better returns.
At an economic meeting in France, Snow described the dollar's slump of nearly 20 percent against the euro since the year began as "fairly modest" and indicated the dollar had more room to fall. Washington no longer gauged the dollar's strength by its market value against other major currencies, he said, implying financial markets should set exchange rates.
This week, the dollar sank to a four-year low against the euro -- the 12-country currency. The euro, after collapsing to a record low of 82 cents in late 2000, now is above its January 1999 high of $1.18 when it was introduced.
The betting is the euro will rise to $1.20 or more because Snow has given a green light for the dollar to head south.
On Monday, the dollar hit 115.10 yen, a two-year low.
Behind the scenes, inflation lurks. For nearly a decade, the strong dollar has curbed the price of imported goods. Americans will now be importing inflation as prices rise for German cars and South Korean high-tech toys. As inflation rises, so will interest rates, now at 41-year lows.
"The immediate negative of a depreciating currency is it could come with higher interest rates and lower stock prices as foreign investors bail out on positions, while the longer- term concern is it will boost inflation," says Rick MacDonald, senior economist for MMS International.
DOLLAR MELTDOWN: THE SEQUEL
The big question is: How much more of a drop would Snow tolerate? Just as troubling: How much more risk will foreign investors accept before dumping stocks they already own?
There's speculation of a repeat of the dollar's meltdown between 1985 and 1987, when it lost up to half its value against leading currencies.
By some estimates, offshore investors own 45 percent of U.S. government bonds, 35 percent of corporate bonds and 12 percent of stocks.
The Street, hoping for a stock market rebound, has another worry. The market will be unsettled by the possibility it may not have turned the corner because of an eroding dollar.
Foreigners have plenty to be skittish about the health of the world's biggest economy. Many are already parking their money in less risky places outside the United States.
Gold is among the few dollar-denominated assets still luring investors, a no confidence vote in the nation's future.
The loss of offshore money could slam the economy, which needs more than $2 billion a day in foreign funds to finance the nation's massive current account deficit of almost $600 billion. The United States has run up a huge current account deficit because it consumes more than it produces.
CHEAP DOLLAR, STEEP TOLL
The risk is President Bush's cheap dollar policy could bite the $10 trillion U.S. economy.
"Bush wants to get re-elected so a lower dollar will help our exporters while the prices of imports will rise to Americans," says James Dines, editor of the Dines Letter. "Around one-quarter of U.S. companies' earnings come from foreign nations, so stimulating exports would presumably help President Bush get re-elected."
Worries about the dollar may become a way of life for investors. Some may not embrace Washington's newfound policy and its impact on the global economy.
The International Monetary Fund warned: If the dollar's drop was steep enough, foreign balance sheets could come under significant pressure, aggravating the threat of deflation in Europe. The fallout could rebound in the United States.
Sure, folks will take comfort in a weaker dollar's benefits for U.S. exporters, hurt by the currency's strength in the last two years. Over 2 million jobs have been lost since 2001.
But weakness of the world's most important currency will burden the rest of the globe. Worth asking: Can U.S. exporters find buyers overseas when job losses curb consumer spending?
As offshore companies' earnings get squeezed, they will cut spending on U.S. goods.
The eurozone's economy teetered on the brink of recession in the first quarter. Gross domestic product fell by 0.2 percent in Germany, 0.3 percent in the Netherlands and 0.1 percent in Italy. The fast-falling dollar dealt the coup de grace to Europe's hopes for a recovery any time soon.
Faced with the highest jobless rate in three years and weak exports, the European Union (News - Websites) cut its growth estimates to between zero and 0.4 percent in the next two quarters.
A stable dollar is crucial to global economic growth.
The shrinking dollar will make it harder for other countries to lick their growth problems.
Maybe the average investor should tape a greenback to his wall so he can remember what it looked like before it shrank.
For the week, the tech-laced Nasdaq composite lost 1.85 percent to end at 1,510.09, while the broad Standard & Poor's 500 fell 1.17 percent to finish at 933.22, based on the latest data. With those drops, the Nasdaq and the S&P 500 broke their five-week string of gains. The blue-chip Dow Jones industrial average closed Friday at 8,601.38, down 0.89 percent for the week. This snapped the Dow's three-week winning streak.
(Pierre Belec is a free-lance journalist. Any opinions expressed are those of Mr. Belec.) |
