Here's an interesting article from today's globe and mail. I wonder to what extent the dollar's slide isn't being orchestrated by the U.S. to pressure China into reevaluating their currency.
theglobeandmail.com
Europe urges U.S. to slash deficit
By BARRIE McKENNA
From Tuesday's Globe and Mail
Washington — A new low for the U.S. dollar against the euro has sparked cries of “brutal” from the top European central banker and revived speculation about China eventually floating its currency.
The dollar's most recent slide, which began after U.S. President George W. Bush's re-election last week, has sent economic shock waves from Europe to Asia as investors fret about the global fallout from record U.S. trade and budget deficits.
The euro briefly flirted with the psychological threshold of $1.30 (U.S.) Monday, before European officials began talking down the dollar. The Canadian dollar, in turn, briefly topped 84 cents, before ending the day at 83.75 cents.
The major worry in Europe is that a weaker dollar — and conversely, a stronger euro — will make the region's exports more expensive and undermine an already shaky economic recovery.
Breaking weeks of silence, European Central Bank president Jean-Claude Trichet said Monday that his patience is wearing thin.
“The recent moves, which tend to be brutal on the exchange markets between the euro and the U.S dollar, are not welcome from the standpoint of the ECB,” Mr. Trichet said after a meeting of central bankers in Basel, Switzerland.
Those sentiments were echoed by French Finance Minister Nicolas Sarkozy, who Monday urged the United States to take steps to reduce its massive current account deficit as a way of relieving the downward pressure on the dollar.
“The U.S. must cut its budget deficit: This is a unanimous message from Europe and the International Monetary Fund which we're sending to our American friends,” Mr. Sarkozy said.
A weaker dollar harms European companies — including drug makers, car makers financial institutions — by making their products less competitive in the United States and depressing profits from their U.S. operations.
The impact isn't all negative. The higher euro keeps inflation at bay by tempering the high cost of oil and other critical imports.
In the United States, the lower dollar has the opposite effect. It raises the cost of many imports, while making its manufactured goods more competitive.
In Washington, the dollar's slide has been met with virtual silence. U.S. Treasury Secretary John Snow, who has publicly insisted that the Bush administration supports a “strong dollar” policy, has remained quiet.
Worried about its growing U.S. trade gap with the rest of the world, the Bush administration has put intense pressure on the Chinese to float their currency.
The swelling current account deficit, which includes both trade and capital flows, is the largest in U.S. history — $650-billion a year, or a hefty 5.7 per cent of gross domestic product.
The chatter about the dollar comes as the U.S. Federal Reserve Board appears poised to raise its benchmark interest rate for the fourth time since mid-June, by a quarter percentage point to 2 per cent. The Fed meets tomorrow.
In China, which pegs its currency to the U.S. dollar, the weaker greenback appears to have stirred new rumblings about a move to what Chinese authorities call a more “flexible” exchange rate regime to help relieve inflation pressures. The falling dollar also fuels inflation by making U.S.-priced oil more costly.
Oddly though, the lower U.S. dollar also serves Chinese political interests.
China has promised the Bush administration that it's ready to move away from the peg, but it wants to do it on its own terms and for its own reasons — not to appease U.S. protectionists, according to Drummond Brodeur, vice-president and portfolio manager at KBSH Capital Management in Toronto. And with the lower dollar making oil even more expensive in China, it offers a pretext for currency reform, he said.
“The weaker dollar gives them an excuse to loosen their exchange rate, because as inflation builds it makes sense for the Chinese to have a flexible exchange rate,” Mr. Brodeur said.
He added, however, that China is unlikely to move swiftly in loosening the dollar peg, moving instead in “baby steps” toward currency reform.
David Rosenberg, chief North American economist at Merrill Lynch & Co. Inc. in New York, said the currency markets are betting that the only way for the United States to dig out of its budget and trade deficits is via a weaker currency.
“[Currency markets are] basically pricing in the reality that we are going have to depreciate our way out of this,” Mr. Rosenberg said.
And that's why the Bush administration is likely to maintain a policy of “benign neglect” when it comes to the dollar.
But Mr. Brodeur warned that China's move toward a flexible exchange rate might trigger a much more precipitous slide in the dollar than many people in the United States would like.
“If the Chinese go to a flexible exchange rate, they would have no need to buy U.S. Treasuries any more,” Mr. Brodeur remarked. “So be careful what you wish for, because the Chinese are underwriting a big chunk of the U.S. budget deficit.”
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