The title of a story on the first Business Page of The New York Times on Wednesday, May 7 proclaims “Signs of Stability, Even Upturn, for Dollar” and it begins “After six years of stumbling against the euro, the dollar may be showing signs of getting back on its feet.” The chart included with the article, however, shows a small, almost imperceptible, upward blip in the dollar/euro exchange rate after a long slide (see chart below). Most notably, one could easily identify other points over the past seven years that, at the time, would be candidates for “signs of stability.” With today’s perspective, however, none of these marked the end of the decline in the dollar. Maybe this time will be different. But maybe not. The article concludes with Martin Feldstein’s observation that the persistent U.S. trade deficit may mean that the dollar “has substantially further to fall.”
There is a concern that a free fall of the dollar could ignite inflationary pressures in the US. But the weak dollar helps US exporters and US firms that compete with imports and, at a time when the Fed is cutting interest rates to spur the economy, a boost from the external sector may be welcome. And, whether or not the dollar decline is welcome, it may be necessary, given continuing external imbalances.
An article in the Financial Times on the day following the New York Times article, however, gives the impression that the dollar’s weakness is not welcome, at least among central banks. This front page article, entitled “US and Europe unite on dollar rise,” begins with the sentence “The US and Europe now have a united desire to see the dollar strengthen against the euro, senior officials have told the Financial Times.” What has been striking about this desire is the lack of financial deeds behind the words. In the past, dollar misalignments have been addressed with central bank interventions, often in a coordinated manner. For example, the dollar weakened by 10 percent in 1994 and then, in the Spring of 1995, began a precipitous plunge against the deutschemark and the yen. This eventually prompted rounds of coordinated intervention by eleven central banks at the end of May. Following this, the dollar rebounded and continued to strengthen through the summer and into the fall of 1995.
Why haven’t we seen central bank intervention this time around? Perhaps intervention is not that efficacious, especially when there are underlying fundamentals that suggest the dollar has further to fall. The interventions in the summer of 1995 may have been correlated with a rebound of the dollar because the precipitous decline preceding the policy actions did not seem to reflect underlying economic reality. The persistent US trade deficits, on the other hand, may require a continued dollar decline. And, knowing this, central bankers are unwilling to expend political capital (as well as their own funds) on an effort to lean against the wind.
Copyright 2008 The New York Times Company
6 Responses to “Dollar’s Rebound?”
The dollar danger is not over yetPublished: May 9 2008 03:00 | Last updated: May 9 2008 03:00When a currency rises after government officials say that it should, you learn one thing: that the fundamentals were pushing it up anyway. It makes sense for senior US and European officials to talk up the dollar against the euro – as they did this week in the Financial Times – especially now that optimism about the US economy makes their arguments plausible. In the long run, however, the real risk of a dollar crisis is against the managed currencies of Asia and the Middle East.Early March was a time of danger for the dollar. There were forecasts of a deep depression, liquidity fears around some of the mightiest banks on Wall Street, and the dollar’s decline against the euro, already rapid, began to accelerate. That decline could have become selfsustaining if investors had begun to dump US assets, but the decisive rescue of Bear Stearns by the Federal Reserve shifted expectations about future US interest rates and restored confidence.Through good judgment, as well as a little good luck, policymakers have so far avoided turning a credit crisis into a currency crisis. Without a run of fresh bad news on the US economy there is little reason for the dollar to fall further.But while the dollar may now be stable, it is stable at well above $1.50 to the euro, a level that is below most estimates of its fundamental value. That probably suits the US – a cheap but stable dollar should boost exports and encourage foreigners to invest – even if it raises the bill for imported oil. The drag on exports is less comfortable for the eurozone, but while the US is an important trading partner, it takes less than 15 per cent of total eurozone exports.But the trouble for both the US and Europe is not each other – it is China, India, Middle Eastern oil producers and a host of other countries that peg or manage their currencies against the dollar.For the eurozone that means that currency overvaluation against the dollar puts pressure not just on exports to the US, but on exports to most of the rest of the world.For the US it is both blessing and curse. Dollar falls would have been far more severe had Asian central banks stopped buying it, but as long as Asian currencies are held down it will be impossible to resolve global imbalances, and the risk of a dollar crash, one day, will grow. The pressure mounts steadily: with US interest rates down at 2 per cent, China is now losing vast sums of money on its foreign exchange reserves. Verbal intervention on the dollar and euro is welcome – but it is time for verbal intervention on the rupee and renminbi as well.Copyright The Financial Times Limited 2008
Very interesting analysis.The G7 Statement at the time of the IMF meetings suggested that the G7 were close to FX intervention; at that time the euro was close to 1.60 to the dollar. That intervention did not occur so far; but since that statement the dollar has somewhat strenghtened relative to the euro; it may not be a turnaround but it is at least going in the other direction. Do you expect such intervention if the euro were to become stronger than 1.6 again, say go toward 1.65 or 1.70. Or is your argument that there will not be any intervention at any level of the euro?
Whatever the case you cannot talk away the structural problems of the U.S. dollar and behave as if it is a cyclical downturn as some of the blind were blurting in the past. It is in the interest of the U.S. economy to avert the devaluation of its currency and all the assets contained within. Unless the U.S. wishes to end commerce with much of the planet it should re consider this banana republic approach to solving its economic problems.
Thanks for your post. Your straightforward explanation for why we have not seen coordinated central bank intervention so far makes a lot of sense. My question for you is: How much of this "rebound" do you think is due to an improving financial climate and the perception the US rate cut cycle could be ending vs. rising doubts about eurozone growth?
China is on its best behavior because of the upcoming Olympics and is "allowing" itself to lose money on the USD. Come November, the world’s trading currency is at the whim of the pent up wrath of an unpredictable giant–just that thought should spook traders by summer. The fundamentals will meet consequences this autumn.
you play the percentages and go with the flow; buck down