... "Barron's" Gene Epstein says that he thinks that the dollar will probably be all right ... on the other hand, he has been wrong about most everything he has predicted in "Barron's" for the last several years, so in many ways, he is a contrary indicator ...
Ken
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Monday, November 25, 2002 - Barron's
No Greenback Blues
The U.S. dollar looks good, especially compared to the alternatives
by Gene Epstein
On growing old, the French singer Maurice Chevalier famously remarked, "Considering the alternative, it's not too bad at all." Well, ditto for the dowdy U.S. dollar. Considering the alternatives, especially the euro and the Japanese yen, the buck is looking pretty good. Say what you want about the poor performance of the U.S. economy, you can generally say worse about Europe's and Japan's. In these unhappy circumstances the global investor, stuck with a series of unhappy choices, must choose the least unhappy to maximize gains. That should serve to buoy the buck in 2003.
For contrary to what the textbooks teach, and the media seem to believe, the fact that Americans import more than they export -- the trade deficit on current account -- has not been the main driver of the dollar's exchange value. If it were, the dollar would have crashed long ago. What really sustains dollar is the net export of U.S. capital assets -- the purchase by foreigners of stocks, bonds, real estate, or whole companies, like the recently announced $14.2 billion acquisition of U.S. consumer-finance giant Household International by HSBC Holdings, the giant U.K. domiciled global bank.
The euro, sole currency of the 12 nations in the European Monetary Union -- including Germany and France, but not Britain -- rose from a low of 86 cents in January to parity with the dollar by July, and has traded around that level ever since. Chances are, that's about as good as it will get for this currency in 2003.
The Japanese yen looks even more vulnerable, especially since Japan's leaders continue to jawbone their own currency -- talking the yen down, the dollar up -- with reasonable success. They prefer a cheaper yen to make their exports more competitive.
Most bets are off, however, if the U.S. goes to war against Iraq. Morgan Stanley global economist Joseph Quinlan believes the looming threat of war has been the key reason why the dollar lost ground to other currencies earlier this year. If the 1991 Iraqi war is any guide, then the dollar will fall as the drumbeat of war grows louder, but then more than recover lost ground if the U.S. takes Baghdad within a few weeks and with relatively few casualties.
But if the war drags on with no immediate victory in sight, then that script will break down, and the dollar's fate gets more worrisome. Ashraf Laidi, chief currency analyst at MG Financial Group, believes that, in the event of war, a key safe-haven currency will be the British pound, mainly because it offers high returns; short-term U.K. interest rates now stand at 4%, compared with 3.25% in the Eurozone and 0.1% in Japan. Moreover, adds Laidi, Britain's nearly balanced budget makes it less dependent than others on foreign financing.
Barring catastrophe, however, the buck's immediate prospects look bright. But not to every interested observer.
Wednesday, German finance minister Hans Eichel haughtily observed that the euro's recent rise against the dollar can be explained by the greater confidence Euroland now enjoys among investors, a preference that is amply justified by concern over U.S. budget and trade deficits, as well as the uncertainties surrounding the country's prospects for growth.
But Eichel spoke nary a word about conditions in his own backyard. So let's help him out. To begin with, when it comes to budget deficits, the Eurozone makes the U.S. look almost tightfisted by comparison. Europe's largest economy -- Germany -- will incur a deficit running 3.8% of gross domestic product this calendar year, and in France, 2.8%. By contrast, the budget deficit in the U.S. came to 1.5% of GDP in the fiscal year ended September, and through 2012, even one of the more dire projections puts it no higher than 1.5% of GDP in any year .
As for future growth, first look at the recent past. In the year ending in the third quarter, GDP in the U.S. rose at 3% annual rate; in Germany by 0.4%. For Euroland as a whole, the most recent data available show annualized growth at 0.7% through the second quarter. And yet, despite this wretched performance, on Wednesday the German government announced substantial tax increases.
Since you'd have to hail from the Darth Vader School of Economic Policy to want to hike taxes when the economy is hurting, the real aim is to appease the codicils of the galaxy's Growth and Stability Pact, which require that each member nation in the EMU cap its fiscal deficit at 3% of GDP. As noted, Germany's deficit is running well above that, which means the government must spend less or tax more to close the gap.
"This is a prescription for catastrophe," remarks High Frequency Economics chief economist Carl Weinberg, "that will help ensure subpar economic growth in the core of Euroland." (For more on Germany's fiscal follies, see European Trader.)
On the potential use of monetary policy, Finance Minister Eichel himself ironically exposed a key limitation. The European Central Bank is currently maintaining the short-term interest rate at 3.25%, compared to 1.25% in the U.S. MG Financial's Laidi predicts that at its Dec. 5 meeting, the ECB will ease by only a quarter point to 3%. Eichel seemed to concur, complaining Wednesday that the central bank could pursue a more growth-oriented monetary policy if only the seven member states with inflation rates above the ECB's 2% target for price stability would rein in their prices, a point of growing resentment for low-inflation states like France and Germany.
Divisiveness of that sort is the main reason skeptics predicted right from the start that the European Monetary Union would eventually dissolve.
When it comes to the dismal performance of the equity markets, Europeans have had it far worse than Americans. Weinberg notes that for every percentage point lost by the U.S. stock market this year, the German market has shed two. Regarding bonds, he points out that "for every percent of capital gains realized by 10-year bund-holders, or holders of other Euroland [10-year government bonds], bondholders in the United States have booked two percentage points of gains." And while an Enron or WorldCom debacle can cause a loss of faith in the financial markets, the pall from those scandals is lifting.
Then there's the U.S. trade deficit. The EMU runs a small trade surplus, while this nation's trade deficit is expected to run 4.8% of GDP this year, and rise to 5.5% by 2003. According to the conventional framework, that deficit must be "financed" by a surplus on capital account: the purchase by foreigners of U.S. capital assets running higher than U.S. investors' purchases of foreign assets. While there's some truth in that view of the way things, it does tend to put the current-account cart before the capital-account horse. The net purchase of U.S. assets first boosts the value of the dollar, making imports cheaper and exports more expensive, which then brings the trade deficit. That deficit on current account will narrow when the surplus on capital account does the same.
That surplus doesn't seem to quit, however; this year, it will set another record. But it's hardly the miracle it's cracked up to be. The U.S. accounts for about 25% of world GDP. So wouldn't it make sense for the rest of the world to invest at least 25% of its assets in the U.S.? Not only does that weighting barely begin to approach one quarter, the U.S. is way ahead in this globalization race, owning in proportion to its size more than twice the assets foreigners hold in the U.S. So if this surplus on capital account can't keep growing indefinitely, it could still take years before the limit is reached.
Then, too, the dollar is sustained by the need to purchase the greenback itself -- not just in $100 bills for nefarious use or by the foreign economies that have been "dollarized" de jure or de facto. The only way to buy crude oil is with dollars; central banks around the world accumulate dollars as a reserve currency.
The Bank for International Settlements recently reported that in the survey month of April 2001, the dollar was on one or the other side of 90.4% of all currency trades, up from 87.3% in April 1998. Considering the alternatives, the buck remains the world's currency of choice.
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