I haven't noticed any weakening of the dollar (other than at the level of noise). On what do you base your perception?
Charlie - greetings. I am not making the point that, at present, the dollar is a problem for the FED, but that it is another consideration that makes rapid and/or consecutive rate cuts by the FED anything but a slam-dunk. I have read several articles, in the last few months, that have talked about the strong likelihood of a major drop in value for the greenback. I will post new articles of value as I read them.
Nor am I trying to validate (to the thread or to myself) my S&P 'puts'. As much as they are helping, the hits I am taking in ABMD and SUNW much more than make up for my 'put' gains.
Ken Wilson
The Economy
It's Time To Worry About the Dollar, Too
By Rebecca Thomas
November 30, 2000
YOU HAVEN'T NOTICED the bang going out of the buck? We can't blame you for overlooking the currency markets this week. After all, the 10.5% fall in the Nasdaq Composite has been a real show stealer.
But backstage, the greenback has also been putting on a poor performance. That could be cause to worry — and not just because it might make your Christmas fling in Paris a little more expensive. A serious downturn in the dollar could ultimately make it much tougher for the Fed to engineer that soft landing we're all praying for.
First, a sawbuck update for those of you who missed it. On Thursday, the dollar fell 1.7% to 87.23 cents per euro, its lowest level since Nov. 3. In the past week, it has moved down by more than 4% against the European currency. In the world of foreign exchange, "that's a significant move for a week," says David Solin, a partner at Suffix, Conn.-based Foreign Exchange Analytics.
There could be worse to come: Citibank's head of global currency, Bob Sinche, figures the dollar could fall another 7% to 8% over the next three to six months. Morgan Stanley Dean Witter chief economist Stephen Roach, a notorious Wall Street bear, goes even further. "The dollar is a disaster waiting to happen," he recently wrote.
The reason: As U.S. growth decelerates, converging with growth in the rest of the world, U.S. investments lose their relative attractiveness. (Indeed, it was the promise of strong growth, ballooning stock prices and high bond yields that lifted the dollar so high in the first place.) "If the U.S. is no longer perceived as relatively stronger, it may cause people to rearrange their portfolios," says Lawrence Krause, associate professor of politics, economics and society at the State University of New York at Old Westbury. A recent decline in both portfolio and direct investments suggests that foreign investors have already begun to lose confidence in U.S. assets - whether they're stocks, bonds, real estate or corporate takeover targets. And when foreigners stop making those U.S. investments, they in effect stop buying dollars.
What's the big deal? Namely that less money is coming into the country just as more and more dollars leave it. U.S. consumers may have stopped buying Gateway (GTW) computers, but they're greedier than ever for Sony (SNE) PlayStations. In September, the U.S. trade gap widened to a record $34.26 billion, thanks in no small part to increased imports of advanced technologies, autos and aircraft.
The gaping current account deficit is the dollar's "Achilles' heel," says First Union Capital Markets global economist Jay Bryson. Foreign investment in the U.S. has offset capital outflows for years. (In other words, we imported lots of PlayStations and Toyotas, but effectively exported even more dollars.) But that trend will reverse if the current account deficit exceeds $400 billion this year and swells to $450 billion next year, as Bryson expects. According to Roach, capital inflows from foreign investors would have to exceed $1 billion per day in 2001 to cover America's external financing gap — an unlikely scenario.
There's another hypothesis for the dollar's weakness. Solin thinks long-term traders are making end-of-year portfolio adjustments to lock in gains. So as not to miss the bandwagon, short-term investors are selling dollars, magnifying the currency's decline. The risk, he explains, is that the selling "takes on a life of its own," snowballing out of control.
It doesn't much matter which theory you believe. Just the perception that less money is entering the U.S. could cause major disruptions in financial markets, says Krause. By selling dollars in anticipation of a currency decline, investors threaten to bring on the very disruption they fear, he explains. Ultimately, if capital flows into the U.S. deteriorate significantly, the Federal Reserve will have less freedom to ease interest rates, even if the economic slowdown warrants looser policy. To stop the deterioration, it may even have to raise rates to make dollar-denominated debt more attractive to foreign investors. That's exactly the bind the European Central Bank has found itself in this year, when it actually raised interest rates six times in the face of 10% unemployment in order to attract capital investment.
A soppy dollar would also give inflation hawks something to worry about. That's because imports become more expensive when a currency declines. In turn, domestic companies can afford to hike their own prices, creating an inflation scenario. The strong dollar has been one of the main catalysts keeping U.S. inflation at bay. Were a significantly weaker dollar to fuel higher prices in a period when energy prices are near nine-year highs and labor markets extremely tight, the Fed might have even less maneuvering room to engineer a soft landing, says Jim Angel, a professor at Georgetown Business School. Higher prices would demand tight monetary policy, even as the stumbling economy was crying out for some slack.
It all sounds pretty scary. But the dollar's recent decline should be put in perspective. The euro, which traded at $1.17 to the dollar when it was first launched in January 1999, has been long overdue for a comeback. And the greenback is holding up fairly well relative to the Japanese yen. It edged down to 110.35 yen on Thursday, from Wednesday's nine-month high of 111.24. "We're looking at a flea's backside," says Kevin Harris, international economist at New York-based MCM Currencywatch, in describing the recent weakness in the dollar.
And most currency experts scoff at the prospect of a currency debacle reminiscent of 1998's. "The U.S. is losing some of its global attractiveness, but it isn't going into crisis at the moment," says Jeremy Fand, global head of foreign exchange for UBS Warburg. First Union's Bryson agrees. "I don't think we're staring at a dollar meltdown," he says. Given what's at stake, we'd all better hope he's right.
smartmoney.com |
