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Strategies & Market Trends : Booms, Busts, and Recoveries -- Ignore unavailable to you. Want to Upgrade?

To: Haim R. Branisteanu who wrote (38212)	9/14/2003 1:22:41 PM
From: Joan Osland Graffius	Read Replies (1) \| Respond to of 74559

Haim, Frank Barbera believes the carry trade is in favor of the Euro. netcastdaily.com

To: Haim R. Branisteanu who wrote (38212)	9/15/2003 2:19:26 PM
From: Haim R. Branisteanu	Respond to of 74559

'US' Versus Them; Why the Currency World is Bi-Polar (Morgan Stanley) Monday, September 15, 2003 morganstanley.com Two of the most notable developments in currency markets in the past two years were the structural USD correction and (2) the fact that this correction has been heavily skewed in favour of the EUR. On the latter, it was well understood that heavy JPY intervention meant downside USD pressure was concentrated against the EUR. However, other Asian economies also run de facto USD pegs, including China, Taiwan, and Korea. Essentially, for the past year, we have been dealing with a currency world that is 'bi-polar', with the USD and currencies in this ‘de facto dollar bloc' on one side, and everything else - led by the EUR - on the other. In my view, the objective of Secretary Snow's visit to Tokyo and Beijing should be seen in the context of the US trying to return the currency world to a 'tri-polar' arrangement. Asia is likely, for now, to insist on staying in the bi-polar world. Contrary to popular presumption, there may be reasons other than export competitiveness justifying these pegs, suggesting further US demands for greater currency flexibility, possible at the upcoming G7 meeting, will likely be repelled. Reasons why Asia feels the need to keep the USD pegs I believe there are three common justifications for all of the de facto Asian USD pegs. Because two of these factors are structural, even without upward pressure on their currencies, it is still likely that Asia would retain a preference for USD pegs. 1. Asia fears losing export competitiveness as the USD corrects. This is the (cyclical) reason most investors may have in mind. There is a direct competitiveness issue with the US but, and potentially more important, no Asian country is willing to let its currency appreciate against the dollar because of fear the others may not follow suit. 2. Asia is increasingly integrated through trade. Asia now trades as much with itself, as the current members of the EU trade among themselves. The production process is also very integrated: raw materials come from outside Asia; capital goods from Japan, Korea, and Taiwan; and final assembly and production takes place in China. Such integration will likely increase. Since, with the exception of Japan, virtually all the Asian countries do not denominate their exports or imports in their national currencies, Asia needs to rely on an international currency (the USD) to denominate these transactions. If intra-Asian trade is increasing and denominated and priced in USDs, to minimise the volatility between the currency in which export revenues are counted and that in which wages are counted (local currencies), it makes sense for Asia to maintain soft USD pegs, even if the USD starts to appreciate. 3. Using USD-pegs as the key nominal anchor for inflation control. By and large, Asia's banking systems are still weak. Instead of using an explicit inflation target or central bank credibility as a nominal anchor for inflation, USD pegs have been used (to varying degrees) among these countries in question instead. Further, through soft USD pegs, Asian countries can 'harmonise' their monetary policies with the Fed, and therefore with each other. Why the US is all of a sudden bothered by the USD pegs. Asia may have reasons to want to maintain soft USD pegs, but does the US want them to peg to the USD? There has been an important change in attitude from Washington on this issue. The combination of the US recovery turning out to be 'jobless' and the election cycle may be one motivation to 'shift the blame' on other countries. Politics and economics are aligning in the US to compel Asia to de-link from the USD. Implications of a bi-polar currency world. First, EUR/USD will be volatile. As long as these soft USD pegs in Asia remain, EUR/USD may be forced to absorb the tensions in the currency world. Second, the USD cannot crash because of Asia's insistence on the soft pegs. Much of the US current account deficit will be automatically financed by Asian (USD-asset buying) intervention. Even if Asia is to be forced to abandon the soft pegs, interventions will likely continue; though the intensity will be tempered. Bottom Line. Asian economies may prefer to keep soft USD pegs, for reasons other than maintaining export competitiveness. If and when the US exerts more pressure on Asia to dismantle the de facto pegs, the Asian countries may put up a tough fight. I continue to expect the JPY-peg at 115 to be broken before the RMB-peg is dismantled.