THE RUN ON THE DOLLAR: I
the dollar: as good as the ruble
LONDON - The dollar plunged for a second consecutive day against the yen before rallying late
Thursday in wild trading that signaled a potentially dangerous turn in the worldwide financial
crisis and provoked steep falls in stock markets around the globe.
The speed and scale of the dollar's fall against the yen over the past two days - at one point
Thursday it was down nearly 15 percent - was more reminiscent of the runs on the Russian ruble
and the Indonesian rupiah than normal trading between two of the world's leading currencies.
The move suggested a stampede by fund managers to unwind speculative investment positions and
seek safety at home, a trend that favors currencies of such countries as Japan, Germany and
Switzerland that run big trade and current-account surpluses.
This heightened aversion to risk among investors, which the chairman of the Federal Reserve
Board, Alan Greenspan, said Wednesday was the worst he had ever seen, could put further
pressure on stock markets, restrict the flow of credit to companies and slow economic growth in
the United States and Europe, analysts said.
''When dollar-yen can have its single biggest move in 25 years, all is not well with markets,''
said Avinash Persaud, a currency analyst at J.P. Morgan in London. ''It's telling you that global
liquidity is diminishing still further.'' J.P. Morgan's U.S. economists predicted that the
tightening credit crunch would tip the American economy into recession next year.
''A move this sudden reinforces the volatility and the uncertainty we've seen recently,'' said
Gerard Lyons, senior economist at DKB International.
The dollar plunged as low as 111.58 yen in European trading Thursday before climbing to
119.365 yen in 4 P.M. New York trading. Even at that level, the dollar was down nearly two yen on
the day and more than 11 yen, or 9 percent, since Tuesday.
The dollar also traded below 1.5900 Deutsche marks at one point before recovering to 1.6340 DM
in New York, compared with 1.6163 DM on Wednesday. The currency turmoil also sent stock
markets reeling around the world.
Prices tumbled on Wall Street because of concerns about slow growth and because the falling
dollar reflected a reduced world demand for U.S. stocks. . . .
A weak dollar also was expected to slow economic growth and reduce earnings of export-oriented
companies in Europe and Japan.
In Europe, equity indexes fell by more than 2 percent in London, by 3 percent in Amsterdam and
by 4 percent in Paris, Frankfurt and Milan. In Tokyo, the Nikkei index of 225 shares plunged
799.55 points, or 5.8 percent, to 13,026.06.
But the volatility was concentrated in dollar-yen trading because of the unwinding of investment
positions by many big institutions, particularly hedge funds. These funds had bought stocks in
the United States and in emerging markets using money borrowed in Japan at that country's
record low interest rates. With stock markets tumbling, these funds are selling stocks and
buying yen to repay their loans.
The problem for Japan is that the resurgent yen threatens to depress economic activity with the
country in the midst of its worst recession since World War II. ''This is a disaster for exporters,
who were the only bright spot in the economy,'' said Marshall Gittler, an analyst at Bank of
America in Hong Kong.
Other analysts expressed concern that the severity of the dollar's move could result in big new
losses of the kind that nearly sank Long-Term Capital Management last month.
Citigroup said Thursday that market turmoil had produced third-quarter losses of $325 million
at Salomon Smith Barney and $130 million in the global banking business of Citicorp.
''Movements in any major asset price on this scale are unlikely to be helpful at the best of times,''
said Giles Keating, an economist at Credit Suisse First Boston.
The dollar's fall could have a silver lining if it leads to interest-rate reductions, particularly in
Europe, analysts said.
In recent days, some analysts have suggested that U.S. authorities were tacitly encouraging the
decline to help relieve financial pressure on Southeast Asian and Latin American countries and
to prompt European central banks to lower their interest rates.
Jim O'Neill, a currency strategist at Goldman Sachs International, said he perceived a subtle but
significant shift in Washington's stance toward the dollar in recent days in the comments by Mr.
Greenspan, which many analysts took as a hint of further Fed easing, and by the Treasury
secretary, Robert Rubin, who voiced concern about yen weakness rather than his customary
defense of a strong dollar.
The Bank of England did cut its key interest rate by one-quarter point, to 7.25 percent, Thursday,
saying that the recent deterioration in the global economy had lowered the outlook for British
growth and inflation. Britain's chancellor of the Exchequer, Gordon Brown, lobbied openly for a
cut this week, saying he would slash his forecast for British growth to 1 percent in 1999 from 2
percent because of the global turmoil.
Denmark's central bank also cut its key short-term lending rate by one-quarter point, to 4.75
percent.
The question now is whether the core European countries of Germany and France will cut rates.
Although they did not rule out a move, German and French officials this week reiterated their
reluctance to do so, noting that their rates were already a low 3.30 percent and that countries
such as Italy and Spain must cut rates sharply before the end of the year for the launch of the
single currency, the euro.
Mr. Persaud of J.P. Morgan predicted that the dollar would continue to fall toward 110 yen and
1.50 to 1.55 DM. The latter level would squeeze German industry and force the Bundesbank to
initiate a Europewide rate cut, he said.
''European companies have benefited a lot from the strong dollar in the last three years, and now
it's moving in the other direction,'' said Talal Shakerchi, chief executive of Meditor Capital
Management Ltd.''The lower the dollar, the more pain there is for these companies.''
In other trading, the dollar rose to 1.3168 Swiss francs from 1.3085 francs and to 5.4784 French
francs from 5.4194 francs. The pound climbed to $1.7110 from $1.7040
International Herald Tribune, October 9, 1998
US Economy
THE RUN ON THE DOLLAR: II
short yen positions unwound with a vengence
Exceptional market volatility yesterday left foreign exchange analysts gasping for words like
"unprecedented" and "extraordinary" to describe a plunge in the dollar by ¥20 over two days.
"I've never seen anything like this in 25 years," said one analyst. "I've never seen standard
deviations like it," said a technical analyst.
The dollar fell to ¥111.6 at one point as traders fell over each other in a rush to the exit. This was
the first time the dollar had dipped below ¥112 since January 1997.
At one point in London it was reported that leading banks were refusing to make prices in
dollar-yen in lots greater than $1m.
"These kind of moves are unprecedented in the floating rate era since the 1970s. It reflects the
depth of global pessimism, not optimism about Japanese fiscal packages," said Steve Hannah,
head of research at IBJ International in London.
The dollar staged a mini recovery, helped by unconfirmed rumours of intervention by the Federal
Reserve.
But at the end of London trading hours the dollar still stood at only ¥118.8, almost ¥5 down on the
previous day's close of ¥123.5, and more than ¥15 down since Tuesday.
Hedge funds that were long the dollar and short the yen have rushed to buy yen to get out of their
positions as the yen strengthened. The race for the door drove the dollar lower and the Japanese
currency upwards.
Japanese officials say that at least one major US hedge fund has been very active in seeking to
buy yen, apparently to repay loans, recently.
Tiger hedge fund group, one of the world's largest with approximately $20bn under management,
was rumoured to have been given a bloody nose with approximately $1.8bn lost so far this month.
"Mr Greenspan intimated last week that he was very surprised that the only hedge fund to go had
been LTCM. This is a reflection of just how short the market was. It is also a reflection of the
lack of liquidity. This increases the volatility," said Jeremy Hawkins, chief economist at Bank of
America.
But as hot money and portfolio flows go into reverse, fundamentals will again become important.
"We are not seeing a fundamental reassessment of Japan, but rather classic risk aversion," said
Avinash Persaud, head of currency research at J.P. Morgan.
"We are seeing a triple whammy. A lumpy, vicious circle. It is flows that matter rather than
economic fundamentals. Overseas investors are unwinding their positions because they have lost
too much money. Japanese investors are staying at home, too scared to invest abroad.
"But because Japan has a very large current account surplus and the US a very large deficit, as
liquidity dries up trade flows will begin to dominate. This is bad news for the dollar."
This all comes as yet more bad news for the Japanese authorities. Officials expressed concern at
the yen's rapid climb.
"Japan is in recession. The domestic side is extremely weak. The last thing they need is for the
yen to appreciate sharply," said Mr Hawkins.
"That could turn a recession into a depression - undermining the prospects for any kind of
recovery."
The Financial Times, October 9, 1998
US Economy
THE RUN ON THE DOLLAR: III
Japanese dump dollar investments: they need the capital at home
With two-fifths of the world economy in recession and the rest struggling to avoid it, a bout of
currency turmoil is the last thing the world needs. But, after currency collapses in emerging
markets and stock market turmoil in the west, currency turmoil has now come to the two largest
economies in the world.
The US dollar, for so long a safe haven for demoralised investors, suddenly plunged against the
Japanese yen. In two days of frenetic trading the dollar lost most of the ground it had gained
against the Japanese currency in the past year. It also dropped against other currencies, though
by nothing like as much.
The plunge seemed to defy the laws of economics. After all, the US economy is expected to expand
by more than 3 per cent this year, while Japan's, gripped by its worst post-war recession, is set to
contract by at least 2 per cent. How could investors justify dumping the American currency for
the yen?
One possibility is that investors have started to worry about US economic prospects. Certainly,
concerns have intensified this week, after remarks by Alan Greenspan, the Federal Reserve
chairman, about the deteriorating outlook. It is also true that hopes of a solution to Japan's
banking problems have risen with the approval of new financial legislation.
But these hardly explain what has been going on. "We did some soul-searching to see if the
passage of the banking bill through the Japanese Diet or the promise of a new Japanese stimulus
package could have triggered this, but this extraordinary rise has nothing to do with the
economics," explains George Magnus, chief economist at Warburg Dillon Read in London.
In fact, this week's gyrations owe more to two special factors, centred on Japan, and to a broader
global phenomenon that has characterised the market turmoil in recent weeks: growing fears of
a liquidity squeeze in financial markets. This last problem has worrying implications for
economies everywhere.
The first of the special factors was a combination of heavy selling of dollars by Japanese financial
institutions together with a decision by hedge funds to unwind their long dollar and short yen
positions.
Japanese institutions are suffering a massive shortage of funds because they require capital to
offset huge bad loans on their portfolios. But foreign banks are increasingly cutting their ties,
convinced that the official estimates of the Japanese banks' bad loans are simply fiction. The
"Japan premium" - the rate that Japanese banks have to pay over the normal rate in the money
markets - has widened considerably in recent days.
Officially it has more than doubled from about 30 basis points to 70 points, but some foreign
bankers in Tokyo say it has expanded to 400 points even for relatively healthy institutions. To
meet their financing requirements, the banks are selling US assets, primarily Treasury bills,
and repatriating money to Japan.
At the same time, hedge-funds are also believed to be selling dollars to buy yen. Many had bet
heavily that the Japanese currency would reflect the downturn in the economy by depreciating to
¥150 against the dollar or even further. To achieve this they had sold yen they did not own. But
the hedge-funds found the yen gradually rising to ¥130, so that when they faced with losses
elsewhere, they decided to liquidate their positions, selling dollars to buy yen and driving the
Japanese currency sharply higher. Yesterday, the Bank of Japan was arguing this massive
repayment operation by western hedge funds was behind the yen's sudden surge.
But the combination of Japanese repatriation and hedge fund repayments was only the most
benign explanation being proposed yesterday. Market rumours suggested there was a second,
more malignant one. "Everyone is wondering if they are smelling a rat," says Mr Magnus at
Warburg Dillon Read. The biggest fear is that another hedge fund could be in trouble and facing
huge losses on its yen positions. They believe its fate could be similar to Long-Term Capital
Management, which had to be bailed out this month in a co-ordinated rescue.
The Bank of Japan said yesterday that there was one big buyer of yen in the market. For example,
Julian Robertson's Tiger hedge-fund, one of the largest in the world, is known to have suffered
losses on its dollar-yen investments. "Rumours of hedge-fund problems will continue to spook the
market every day, until financial stability returns," said Jeremy Hawkins, chief economist at
Bank of America in London. "It's all looking distinctly horrible."
Indeed, the speed with which the dollar fell - the fastest since floating rates were reintroduced in
the 1970s - meant that almost every investor has been caught on the hop. And if few had expected
the dollar to weaken, all were stunned by the velocity of its decline, from ¥131 on Tuesday to
below ¥112 at one point yesterday. The dollar bounced back a little in New York trading to reach
around ¥119, but was still a far cry from its recent low in August of ¥147.
These short-term explanations for the weakening of the dollar suggest that part of the currency
movements might be attributable to one-off factors - and hence the dollar might recover. But only
part. After all, the dollar has fallen more than one-fifth against the yen from its peak in early
July. It makes sense to ask what the consequences of a long-term weakening dollar might be.
Some Japanese companies would be hit. A stronger yen would devastate the prospects for Japan's
export-orientated companies. These have been virtually the only sector that has been keeping the
Japanese economy from tumbling into a deeper recession. Shares in Toyota, the country's second
biggest company by market capitalisation, tumbled more than 10 per cent yesterday.
But a stronger yen will also do some good in Japan. The country's biggest single problem over
the past few years has probably been the weakness of its banking system. The banks' main
difficulty is that they are undercapitalised. A stronger yen should help them rebuild their balance
sheets: to that extent, it should soothe the economy's running sore and be, on balance, a benefit.
A weaker dollar should also take some of the pressure off the currencies of emerging markets in
Asia and Latin America. It should enable them to export more to Japan. And though it would make
their exports more expensive in the US, their currencies have fallen so far this year that should
not matter much.
In Europe, on the other hand, a weaker dollar could prove a problem. It dumps a big policy dilemma
in the European Central Bank's lap on the eve of the euro's launch, just when the Bank will have
to do most to establish its credibility.
The rise in European currencies could tighten monetary policy in the euro-zone. It reduces
import prices and hence the overall price level. Unless the ECB cuts rates, the nominal interest
rate will stay the same while prices fall - ie, real interest rates will rise.
That is a big reason why the ECB is coming under pressure to cut rates below the German and
French benchmark of 3.3 per cent. But European officials warn against over-optimistic rate cut
expectations. The predominant view among central bankers is that the euro-zone will be relatively
shielded from strong currency fluctuations. This week in Washington, Otmar Issing, chief
economist of the ECB, hinted that the Bank's future monetary policy strategy would be based on
monetary targets, supplemented by an implicit inflation forecast. Since money growth is
relatively robust in the euro-zone, the ECB could find itself wanting to move interest rates up
when the rest of the world wants them to fall. Hence a weaker dollar could bring a baptism of fire.
But the most striking - and alarming - aspect of the movement in currency markets this week
was a broader disappearance of liquidity. The spreads on the dollar-yen exchange rates - an
indication of how liquid a market is - widened to levels normally expected of a developing
country's currency. With few buyers in the market, liquidity dried up, adding to volatility.
This is at the heart of the broader recent financial problems. The problem, as Mr Greenspan said
this week, is that investors are avoiding risk, and opting instead for the most risk-free, and liquid
assets they can get their hands on.
"What is occurring is a broad area of uncertainty or fear," said Mr Greenspan this week. "When
human beings are confronted with uncertainty, meaning they do not understand the rules or the
terms of particular types of engagement . . . they disengage."
The consequences of such disengagement could be scary. Instead of providing funds for
worthwhile investment in longer-term projects, investors may just want to hold their money in its
most accessible and easily liquidated form. That would mean a massive global credit crunch, with
funds for even the most creditworthy of borrowers cut off.
Some argue this tightening is already going on. The widening of spreads between low-risk
instruments such as US Treasury bonds, and higher- yielding, riskier assets such as corporate
bonds, has intensified in recent weeks. Furthermore, the sharp declines in stock markets around
the world has raised the cost of equity capital for companies.
Other economists think talk of a credit crunch is overdone. There is no question that in Japan
and much of Asia, the condition of financial institutions has squeezed the supply of funds to
business. But in the rest of the world, there still seems to be no obvious shortage of liquidity.
Money supply is growing strongly in the US and Europe.
"Certainly banks and investment banks cutting back on lines to leveraged investors," says
Mickey Levy, chief economist at Nations Bank in New York. "But I don't yet see a general
limitation on credit that would affect the economy beyond the financial sector."
The growing aversion to risk still seems confined, in fact, to financial markets. What concerns
policy makers is whether those fears will jump from the financial sector to the rest of the
economy. In the circumstances, Mr Greenspan seems to have decided that a steady easing of
monetary policy is the best insurance policy he has.
The Financial Times, October 9, 1998 |
