... this is interesting ... as a contrarian, I might take this to mean that the dollar will quickly bottom in this cycle, and possibly rally ... on the other hand, I might think something much more bearish ...
Ken Wilson
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June 3, 2002 - THE WALL STREET JOURNAL
No Safe Haven: Dollar's Slide Reflects Wariness About U.S.
By Jacob M. Schlesinger and Craig Karmin
The dollar appears to be beginning a long-anticipated slide, and that could keep U.S. stock prices in the doldrums and put upward pressure on interest rates.
The dollar's decline against the euro, the yen and other major currencies signals a slackening of global investors' seven-year ardor for the American economy, which helped to propel this country's bull market of the late 1990s. A growing number of global money managers have begun to find other parts of the world more appealing, which threatens to reduce the more than $1 billion a day that foreigners have been sending to the U.S. in recent years.
"A love affair is dying," Morgan Stanley investment strategist Barton Biggs observed after a recent trip through Europe.
A sustained fall in the dollar would have other consequences. The impact would probably be an uptick in inflation, by boosting import prices and making it easier for domestic manufacturers to raise their own prices. On the positive side, it also could bring an increase in exports that would boost overall growth.
The value of a nation's currency is a weather vane, showing the direction the winds of international capital are blowing. When investors send more money into the U.S. than they take out, the dollar strengthens because investors need dollars to buy U.S. assets. The weather vane now seems to be turning: The dollar last week traded at a six-month low against the yen and near a 16-month low against the euro.
Although the dollar has seen ups and downs before, the significance for markets could be far greater this time because the U.S. has become dependent to an unprecedented degree on foreign capital. Any sign that overseas investors are losing appetite for U.S. investments has bigger implications than in the past.
End of an Era?
A continuing fall in the dollar could signal the end of an era that began around the mid-1990s when the American economy was seen as invulnerable. The escalating infusion of capital and the rising dollar were key to the virtuous cycle of American prosperity. Foreigners sent money to the U.S. assuming they could get better returns than anywhere else. U.S. companies used that money to buy new high-tech equipment that helped fuel the productivity boom that raised the economy's growth rate, corporate profits, and stock prices -- making the U.S. an even more attractive place to invest. The rising dollar made returns even higher for foreigners when they converted gains into their own currencies.
From July 1995 through February, the dollar rose nearly 50% in value, measured against a basket of currencies of U.S. trading partners that is monitored by the Federal Reserve Board. Money moved into the U.S. in gale force. In 1997, the U.S. imported a record net $254 billion in foreign capital in all forms, according to the Commerce Department, twice the record set during the 1980s expansion. And last year, foreigners sent $455 billion net to the U.S. Data for this year's first quarter are scheduled to be released later this month.
The seemingly invincible dollar encouraged foreigners to keep buying U.S. stocks, bonds, companies, factories and real estate. It also helped contain inflation by reducing import prices and making it harder for U.S. manufacturers to raise prices.
All that came at a cost to U.S. manufacturers and farmers, who have been screaming that the American currency's strength is pricing them out of overseas markets and -- by reducing the price of the imports with which many of them compete -- squeezing them at home, too.
So Jerry Jasinowski, president of the National Association of Manufacturers, calls the dollar's recent decline "good news." He's rooting for an even more substantial drop than the modest 3% slip against a basket of currencies so far this year. "We'd like to see the dollar continue to reflect market conditions and decline 15% to 20% this year," he says.
In the 1990s, everything seemed to go right for the U.S. economy, and the dollar's strength reflected that. Though the recent recession is over, a return to that past rapid growth seems unlikely. The U.S. stock market is no longer seen as a one-way bet. After years of double-digit returns, the Standard & Poor's 500 index dropped more than 10% in each of 2000 and 2001. It is off another 8% in the first five months of 2002.
Boasts about world-class corporate disclosure, bookkeeping and regulation of American financial markets have become laughable in the wake of the Enron and Arthur Andersen scandals. Washington's reputation for rising above politics in favor of sound economic policy -- symbolized by budget surpluses and free-trade agreements -- is sullied with the return of deficits and protectionism. And now that the U.S. has become a target for terrorists, the U.S. no longer seems a safe haven.
"I think the depreciation of the dollar will continue, because of the growing distrust toward the U.S. financial system," said Jeong Young Sik, a senior researcher at South Korea's Samsung Economic Research Institute.
Improving Prospects Overseas
The dollar's weakness comes as more global investors, including in the U.S., see improving prospects for parts of the world that fared poorly in the past decade.
"There are numerous good values to be found overseas," says James Hunt, a global portfolio manager at Tocqueville Asset Management in New York, who has increased his non-U.S. holdings to about 20% of his total portfolio from less than 15% at the start of the year. The strengthening euro makes returns on new investments across the Atlantic even higher, tempting him to shift even more money there, he says.
Andrew Parry, chief investment officer for Northern Trust Global Investment (Europe) Ltd., a London-based money-management firm, began shifting funds in April from U.S. stocks to Asian markets. South Korea, he says, is growing faster and its stock prices are much cheaper relative to earnings than in the U.S. He is even placing some bets on beleaguered Japan, expecting at least a short-term bounce. "U.S. corporate profits haven't delivered what people had hoped for," Mr. Parry says. "Overseas, you have better valuations."
Investor sentiment also now seems to be improving about Europe, and the market seems to have more confidence in the euro, which slid steadily after its launch and the creation of a new pan-European central bank in 1999. Christopher Wolfe, global equity strategist for J.P. Morgan's private bank, has moved more than $1 billion out of the U.S. to overseas markets. So far, it has been primarily to Asia, but now he's looking more at Continental Europe. "Once we see some of the structural reform in Europe, we plan to move even more money there," he says. "We expect to see more progress in these areas later in the year." The euro traded Friday at 93.07 cents, down from 93.77 cents Thursday, but up from the 89.04 level where it began the year.
Foreign capital is especially important to the U.S. economy because Americans save so little, and that's the only other way an economy finances investment. Although the U.S. government increased its savings as it began running budget surpluses in the late 1990s, American households, which haven't been thrifty in a generation, saved less. The household savings rate -- the fraction of aftertax wages that isn't spent -- fell from 8.7% in 1992 to 1.6% in 2001.
Foreign investors made up the gap. Today, foreigners hold 40% of U.S. Treasury marketable debt, 24% of the U.S. corporate bonds and 13% of U.S. equities, according to estimates by money manager Bridgewater Associates of Westport, Conn.
Even in the best of times, few economists or market analysts believe this trend is sustainable. Foreign money tends to be less loyal than domestic money and can flow out more quickly if sentiment about an economy's prospects shifts suddenly. Though nobody expects the U.S. to suffer the fate of emerging markets, there are unnerving parallels with countries such as Thailand and Argentina, which became unusually heavily reliant on foreign capital.
"There are ever-increasing claims on the American economy by foreign investors and that can't go on indefinitely without some difficulty, history tells us," Federal Reserve Chairman Alan Greenspan told Congress earlier this year.
The U.S. economy still has tremendous underlying strengths -- and remains the world's most attractive economy to many investors. America's late-1990s productivity boom appears to have survived the recession. The Labor Department reported Friday that output per worker hour -- the measure of the economy's efficiency -- rose at an eye-popping 8.4% seasonally adjusted annual rate in the first quarter, the fastest pace since 1983.
But capital flows and currency values reflect the relative appeal of markets, not absolute rankings. Even if the U.S. remains No. 1, a narrowing of the gap with other economies will divert money and depress the dollar. UBS Warburg economists talk of an "equalization of investment opportunities, the result of the investment overhang in the U.S. and important economic changes in Europe, and, in particular, in Asia." They note that a wide range of economies -- Australia, New Zealand, Canada, South Korea, Thailand, Malaysia, Indonesia, the Philippines -- all appear to be pulling out of recession faster than the U.S.
Dicey Proposition
Forecasting foreign-exchange markets is always dicey. Analysts have been wrongly warning of a dollar collapse for years. Even after Sept. 11, the dollar dipped only temporarily and then gained strength. "This process will end at some point," Mr. Greenspan said recently, referring to ever-increasing capital infusion in the U.S. and the rising dollar. "But I've been forecasting this for five years," he added.
One force helping the dollar -- at least compared with the yen -- is the Japanese government. It is aggressively buying dollars and selling yen in foreign-exchange markets, fearful that a stronger yen will make its imports less expensive and aggravate Japan's nettlesome deflation. A stronger yen would also hurt Japan's exporters, who carry a disproportionate burden in the Japanese economy. On Friday the Bank of Japan made its third foray into foreign-exchange markets in two weeks, helping push the dollar up slightly, to 124.38 yen in New York trading Friday from 123.05 yen Thursday, but well below its Jan. 1 level of 131.06 yen.
Still, many economists believe the dollar is beginning a slow, steady decline. Macroeconomic Advisers LLC, a St. Louis forecasting firm, says, "We assume the broad, real trade-weighted value of the dollar declines another 6% through the end of 2003." Mark Zandi, chief economist for Economy.com in West Chester, Pa., expects the dollar "to depreciate by some 10% beginning later this year and extending through the mid-part of this decade."
Officially, the Bush administration still embraces the "strong dollar policy" of the late Clinton years. But policymakers haven't signaled worry about the prospects of a further drop, nor shown any inclination to try to stop one. Lawrence Lindsey, head of the White House National Economic Council, dismisses the latest dollar decline as a mere "wiggle." He insists that the U.S. remains "the pre-eminent place in the world in which to invest."
In contrast with the market-meddling Japanese, the current U.S. Treasury is hesitant to tinker with exchange rates. "There's a real doubt about the effectiveness of interventions or words about interventions," Treasury Secretary Paul O'Neill told Congress last month.
-- Greg Ip and Jason Booth contributed to this article |
