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Strategies & Market Trends : ahhaha's ahs -- Ignore unavailable to you. Want to Upgrade?

To: ahhaha who wrote (23)	9/25/2000 3:05:46 PM
From: ahhaha	Read Replies (3) \| Respond to of 24758

From the Morgan Stanley Dean Witter Economic Group, part 2: Currencies: Intervention Rap Joahcim Fels (London) Mark your diaries. Precisely on the day of the 15th anniversary of the Plaza Accord, in which the G7 agreed to (successfully) weaken the US dollar, the major central banks of this world conducted their first co-ordinated FX intervention to support the EUR. A brief statement issued by the ECB and repeated by the Japanese MoF and the US Treasury after a first round of intervention today says "On the initiative of the European Central Bank, the monetary authorities of the United States and Japan joined with the European Central Bank in concerted intervention in exchange markets because of their shared concern about the potential implications of recent movements in the euro exchange rate for the world economy." Other central banks, including the Bank of England, the Bank of Canada, the Bundesbank and the Banque de France also participated. In short, I believe that this is a very significant move that will be successful in setting a floor under the EUR/USD rate. Here are my preliminary thoughts on the main questions posed by the intervention. (However, I reserve full judgement until after the G7 meeting this weekend.) Why did the ECB intervene? I explained the rationale for ECB intervention in a piece entitled "ECB Intervention: The Time Is Ripe" in FX Pulse dated 21 September 2000. First, the weak EUR, along with higher oil prices has become a major threat to price stability in the euro area. Hiking interest rates aggressively further in order to contain these inflation risks would dampen domestic demand and could weaken the euro further. In these circumstances, ‘clinical surgery’ to push up the euro makes economic sense and is fully compatible with the ECB’s stated monetary policy goal of preserving price stability. Second, with the euro dwindling, the risk of a confidence crisis not only in the currency but also in the EMU project at large had become very real. Why did the Fed and the BoJ go along? It was fairly obvious that the Japanese MoF would go along with the ECB. First, excessive yen strength against the USD and the EUR might derail the Japanese recovery. Second, with many Japanese investors reportedly still long the EUR and their positions under water, the financial sector could have been weakened by a further fall in EUR/JPY. The real surprise is that the US Treasury agreed to intervene, using its own reserves. In my view, as I hinted in yesterday’s FX Pulse, the fact that corporate America’s bottom line and the equity market at large have recently been negatively affected by the USD’s excessive strength probably helped tip the balance in favour of intervention. Does this change the ECB rate outlook? The answer is no. If anything, this supports Elga Bartsch’s and my call that the ECB will hike rates once again by 25 basis points by early November at the latest, but will then put rates on hold. Intervention usually is most successful if it is co-ordinated and followed by appropriate monetary policy action — that is, a tightening in the ECB’s case. While we wouldn’t rule out a move as early as the next ECB council meeting on 5 October, we don’t think the ECB is in a rush after the 31 August hike. What is the goal — putting in a floor or an "orderly reversal"? As our currency strategist Aisling Freiheit-Kinch notes, the language of this weekend’s G7 statement will be important in this respect. Our joint guess is that the US is not interested in putting the USD on a downward slope — as confirmed by Treasury Secretary Summers’ statement that a strong dollar continues to be in the US’s interest. Hence, the goal is more likely to be to put a floor under EUR/USD and EUR/JPY in order to end the one-way bet against the EUR. This is similar to the MoF/BoJ’s strategy earlier this year to end JPY appreciation by introducing "two-way risk" back into the market. Will the intervention work? The first couple of rounds have been successful in pushing EUR/USD higher. By intervening jointly and catching the market by surprise, the authorities have sent a very strong signal that markets are likely to respect. My personal view is that the G3 will ensure by repeated intervention that the lows for EUR/USD are behind us, if and when markets test their resolve. The near-term path for EUR/USD is likely to be bumpy as the fundamental drivers behind the USD’s strength — strong capital inflows in response to an exceptional growth performance and a lead on the technology front — are still largely in place. However, European investors will think twice before piling into US assets now that the central banks have signalled they won’t tolerate further USD appreciation. Also, US investors will probably take a closer look at European assets now that the risk of a further EUR downdraft has been much reduced — European assets must look cheap at current exchange rates. Hence, I see no reason to abandon my medium-term positive stance on the EUR, which remains based on the view that Europe’s long-term growth prospects are generally underestimated. Yes, I’ve been long and wrong the euro for almost a year now, and it has been painful. Yet, with central banks now having joined that side of the trade, it would foolish to abandon the call. His evaluation is excellent, but that's no way to make munnee. He has implied that there is a fundamental weakness which intervention only superficially addresses. History has never been kind to the position that CBs may take against fundamentals. The Euro weakness represents fundamental inefficiencies in the economies of Europe vis-a-vis the rest of the world. Europe is high tax socialist and therefore can't hope to be competitive. Inefficiency doesn't only show up as inflation. It can also show up in mistaken interest rate policy implemented in reaction to the appearances of inflation. The result of raising interest rates in a high tax economy causes final demand to slow but slows inflation disproportionately, so the result is lower effective productivity or less demand for output from the rest of the world. When a cost factor like oil deflates final demand but causes mistaken interest policy to be applied, corporations must raise prices at the margin and this causes foreign demand for European output to slow. Fels states convincingly that these trends won't go away any time soon especially under the backdrop of continued firm oil prices, so there's no reason to assume that the Euro will do anything more than consolidate. Therefore, he has to use CB largesse to sell his Euro position or to abandon his view that Europe has an "underestimated long term growth potential". What isn't appreciated is that high taxes don't merely create a constant disproportionately in efficiency so that Euro would stabilize at a certain low level, rather they create an environment of progressive deterioration. This deterioration will either cause the destruction of socialism and high taxes or the failure of the Euro and a mad dash scramble by European countries to re-establish their individual currencies. Such a scramble would create a strong CB demand for gold just when the other CBs decide to curtail giving it away.