In Memorial of the Euro’s Launch Price, by Ashraf Laidi
(FOREX News)
Currency traders shall remember Memorial Day 2003 as the date in which the euro finally rose above its 1999 launch price of $1.1847. Perhaps the euro is far from having written the dollar’s obituary on Memorial Day. But the situation is looking increasingly ominous for the dollar. Almost a week after the chief spokesman of the US currency redefined the long-standing strong dollar policy to be concomitant with the difficulty of counterfeit and store value--rather than with its market value in the financial markets, and less than a week after one of the world’s better known currency players elucidated markets on his plans to sell the currency, the US dollar continues to slump.
One cannot speak about the euro’s impressively symmetric comeback without exposing the deteriorating economic and political fundamentals of the US currency. Emerging Twin deficits, tepid capital spending, weak consumer confidence, paltry returns on short-term money and the lingering risk of geopolitical uncertainties (including today’s deaths of 2 US soldiers in Iraq) are serving to quash any prospects of a rebound in the US currency. So let’s take advantage of this occasion and put things in perspective in capturing the unraveling deficiencies encompassing the US currency.
Wrong Place At The Wrong Time
The dollar’s decline is a cogent manifestation of a currency being in the wrong place at the wrong time. The downtrend began in March 2002, coinciding with:
- The Bush administration’s decision to impose a 30% tariff on US steel imports, prompting shudders amid major trading partners.
- Later that month, US manufacturers, feeling the bite of the strong dollar and the emerging recession, launched a boisterous offensive against the Administration’s “strong dollar policy”, on the grounds that the overvalued dollar was contributing to their deteriorating competitiveness and heightened slump.
- The fall of the currency gained speed as mounting revelations of corporate fraud and accounting malfeasance eroded market confidence, prompting investors to delve into the meaning of capitulation.
- Just as the falling dollar began to stabilize in late summer/early autumn following the Securities Exchange Commission’s deadline for US executives to certify the veracity of their financial statements, the currency faced renewed damage as the US further isolated itself by launching a diplomatic, then military offensive in Iraq.
With the dollar losing 23% in trade-weighted terms from its 2002 high, the downtrend is increasingly looking like it’s here to stay. The ballooning trade deficit finally appears to encounter difficulty in garnering the necessary financing from abroad. Last year, total net foreign investment in US assets fell for the first time in 4 years. Net foreign flows in US stocks fell by a third in 2001, and more than halved in the following year. Net foreign purchases of US corporate bonds fell 18% in 2002, posting their first annual decline in 7 years, raising the risk that US capital markets will not draw sufficient capital to finance the external gap. Such fears resurfaced in February when total net capital flows from abroad dropped 31% over January, posting the third consecutive monthly decline, the first of its kind since the 3 months following September 2001. And the last time before that-- net inflows fell 3 months in a row-- was in the Dec 98-Jan 99 period, when global investors remained leery of the “Brazil-Russia-Asia 1998 risk” spilling onto the US.
Indeed, the US dollar did hit 15-year highs just over 2 years ago, shunning the US trade gap. But that was then--- when neither corporate fraud nor geopolitical risks appeared in currency desks’ radar screens. Today, the dollar rests on a questionable foundation, characterized by mounting trade and budget deficits. The pervasive threat of terrorist attacks could still loom large as long as multilateralism dominates US foreign policy.
War Was Short But Not Its Impact
Since the war in Iraq, both stock and bond markets in the US continued to amass fresh gains throughout. While the S&P500 has risen 20% from mid March to today, the yield on US treasuries is finding much resistance, delaying the oft-talked about bear market in bonds. Although the Saddam regime has fallen, the impact from the war is far from over. Uncertainty from the war in Iraq has prompted businesses to further delay spending on capital outlays, new orders and hiring. This in turn has damped already soggy consumer expenditure, driving confidence to 10-year lows. A domino effect also tends to filter back through to businesses, when consumers scale back purchases. Although oil prices remained largely stable during the war, the economy remains burdened by rising budget and current account deficits estimated as high as 5.3% and 3.5% of GDP this year respectively. The $70 billion spent on the war and the $60-70 billion allocated for rebuilding Iraq will keep the Federal budget in the red for years to come. Not to mention projected defense spending that could have been allocated to beleaguered industries such as airlines and telecom.
Escalating deficits in US States are also retarding hopes of a recovery in the nation’s economy. California’s budget shortfall stands around $35 billion while New York’s is at $11.5 billion. The effectiveness in which Washington’s stimulus package overcomes these local deficits remains doubtful, especially when the core of the stimulus revolves around tax cuts rather than increased spending. What initially stood as a $750 billion tax-based stimulus package designed to promote expenditure and investment by individuals and some corporations, looks like will end up a little over half that amount. And until whatever left of that fiscal stimulus will filter through in the second half of the year, the economy remains dependent upon the soothing words of the Federal Reserve in assuring markets of its ability to deliver unprecedented emergency measures in combating the risks of deflation.
From Peace Dividend To War Premium
As US foreign policy assumes a preemptive posture, the US economy and the dollar will suffer the erosion of the peace dividend, which prevailed throughout the 1990s, when governments savings realized from reduced military spending were allocated to troubled sectors. No longer is the case today. Already down 20-30% against the major currencies, the dollar rests on a shaky foundation as investors seek high yield and low risk.
Not Exactly Like The 80s…
Amid the key distinctions between today’s twin deficit environment and that of the mid 1980s is the level of interest rates. Double-digit interest rates served as a generous destination for foreign investors seeking high yield, which contributed to the soaring dollar. Today, the emerging combined imbalances, albeit lower than 2 decades ago, are accompanied by the lowest interest rates in nearly half a century. Not only global investors have a host of higher yielding alternatives such as the Australian dollar, Canadian dollar and euro, but they also can find opportunities in several currencies with far geopolitical risk than the dollar. In the risk reward equation, the dollar has lost the peace dividend while accumulating the geopolitical risk.
While most of this piece has been allocated to highlighting the factors conspiring against the dollar, it seems like no credit is given to the Eurozone for its soaring currency. Indeed, the single currency represents an economy with its own set of structural lacunae, such as high unemployment, restrictive fiscal policies, and high interest rates governing disparate inflation and growth rates. Yet the concentration of economic, financial and geopolitical risks in the US have finally lead to the culmination of a stark mis-pricing in the value of the US currency, triggering a necessary readjustment, facilitated by the Bush administration’s rhetorical backtrack from a strong “dollar-policy”, and prompting a categorical attack on the currency.
-May 27, 2003
forexnews.com |
