Analysts Hope the Weakening Dollar Will Avoid a Sudden Plunge
By JONATHAN FUERBRINGER
Published: January 2, 2004
THE dollar plunged against most of the world's currencies in 2003, putting in its third-worst performance since it began trading freely in the 1970's. It was the dollar's second consecutive annual decline, and many forecasters see a further weakening this year.
If contained, a decline in 2004 would generally be good for American business and for Americans investing abroad. But a sudden plunge of many percentage points, which some analysts say is possible, could undermine financial markets here and abroad.
Robert Sinche, global head of currency strategy at Citigroup, expects the dollar to drop further early in the year and then rebound, ending 2004 up more than 6 percent against the euro, which he predicts will be around $1.18.
But he warns that the dollar's recovery could be short-lived. "The trend is there for a weaker dollar," he said, which means that the decline could resume in 2005.
In a more bearish forecast, David S. Gilmore, a partner at Foreign Exchange Analytics in Essex, Conn., predicts that the dollar could fall as much as 13 percent this year, ending with the euro around $1.45. That would put the dollar's value at or close to where it was in 1995, when it hit its post-1971 low against the German mark, one of the 12 European currencies merged into the new euro.
"The dollar is one beaten-down beast," Mr. Gilmore said. And he warned that there was a chance the decline could be fast enough "for things to get ugly, for disorderly markets and for interest rates to go up and stocks to go down.''
"The risk is greater than 5 percent," he added, "and that is statistically significant."
Whether the dollar continues to fall - and, if so, how far and how fast - will depend to some extent on the Bush administration, which says it supports a strong dollar, on the one hand, but still has been lobbying China and Japan to allow their currencies to strengthen and let the dollar fall. This is believed to be part of an election strategy to help make American companies more competitive.
The Federal Reserve will also be an important player, as it is expected to begin raising its target for short-term interest rates this year, perhaps as early as midyear. Foreign exchange analysts are divided over whether higher rates will help or hurt the dollar.
Some argue that Fed rate increases will confirm that the economy is back on a solid and steady growth path, which should help keep the stock market rally going. If stocks rise enough and interest rates are high enough, more foreign investors might be attracted into American markets.
Other analysts warn that in the past the dollar has been undermined when the Fed raised interest rates. The last cycle of Fed rate increases was in 1994, and in April 1995 the dollar responded by hitting new lows against the German mark and the Japanese yen.
Then there are China and Japan, which prevented the dollar from falling even further in value than it could have last year. China's currency is pegged to the dollar, so instead of rising against the dollar last year, it maintained its value, limiting the dollar's overall slide. But if the Chinese peg is loosened, the dollar could tumble further against most Asian currencies.
The Japanese government spent about $187 billion, or more than 20 trillion yen, through Dec. 26 intervening in the currency markets to buy dollars to curb the yen's climb. A rising yen would increasingly crimp the business of Japanese exporters.
The government had never before spent so much to prevent the yen from rising, and many currency traders and analysts now joke that the Japanese have a fixed currency, just like the Chinese.
Without this intervention, the dollar, which fell 9.6 percent against the yen last year, could have fallen as much as 16 percent, some analysts say. And because of the intervention, they believe the dollar will not fall as far against the yen as against the euro this year; some forecasts show only a 4 percent to 5 percent decline, to around 103 to 101 yen.
Lastly, the American economy and stock market will have an impact. So far, the resurgence of growth here and the stock rally have not lifted the dollar. The low-interest-rate environment fostered by the Fed and the record deficit in the nation's current account - which measures the United States' balance of trade in goods and services with the rest of the world - could make investment here less attractive to foreigners.
The dollar fell 12.1 percent against the euro from the beginning of the stock market rally in March through year-end; its decline for the whole year was 16.5 percent, with the euro valued at $1.2572 on Dec. 31. Against the yen, the dollar fell to 107.36 yen.
Against a broad index of the United States' main trading partners, the dollar was down 8.7 percent, the steepest decline since 1987, when it fell 12.2 percent. The year before that, the dollar was down 9.5 percent. But those declines were in a different environment. The dollar soared in the early 1980's, leading the United States and its allies to agree to push it lower. Last year, the dollar also fell sharply against the Canadian dollar, the Australian dollar and the British pound. Among major trading partners, the dollar rose only against the Mexican peso.
AMERICANS investing abroad will benefit from the dollar's weakness, as gains from overseas are increased when they are translated back into dollars. Last year, the returns from stock markets abroad, as measured by the Morgan Stanley Capital International all-country world index excluding the United States, were nearly doubled for American investors, as a result of the fall in the dollar. The 19.9 percent return in the local currencies of the countries in the index translated into a dollar gain of 37.5 percent.
American exporters and the economy in general also benefit from a weaker dollar, as American goods become more price competitive abroad, while imports become more expensive here, helping American competitors.
In addition, a modestly falling dollar is what most economists prescribe as the long-term antidote to the country's growing current account deficit. That deficit is running at a record annual rate of $500 billion.
But Americans will have to pay a lot more to travel abroad for business or pleasure.
A precipitous fall in the dollar is possible because the worsening current account deficit requires an increasing flow of money from abroad to cover the widening gap. Through the first three quarters of last year, the foreign flow into stocks and bonds actually picked up over the 2002 pace, possibly curbing the dollar's fall.
Most forecasters, however, are predicting an orderly decline, not a precipitous one, in part because the dollar's decline so far has not hurt either the stock market or the bond market, where interest rates are still low relative to the economy's growth in the second half of last year.
The current account is Mr. Gilmore's principal reason for predicting a steep, though not disorderly, dollar decline this year. He says he does not think the country can attract the foreign capital needed to bridge the gap, given the dollar's current value. So it will fall further. "Admittedly, evidence of funding shortfall is hard to come by," he said. "But it sure feels that way."
Jeremy Fand, senior proprietary currency trader at WestLB in New York, is in the contrarian camp, predicting that the dollar will get help from the stronger American economy. But he said this support would materialize only when the Federal Reserve made it clear that interest rates were going higher. A rise in rates, Mr. Fand argued, would show that Fed policy makers were confident about the economic outlook.
"The current account becomes irrelevant when the Fed raises interest rates," he argued. "The dollar should rally."
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