US dollar plunges, tips deflation fears Europe's way

AFP ^ | 19 May 2003

[Hal1950]

WASHINGTON (AFP) - Nerves gripped investors worldwide after US Treasury Secretary John Snow appeared tacitly to abandon an eight-year policy of supporting a strong dollar.

The perceived shift raised fears that further dollar declines would erode the value of foreigners' US investments, economists said.

And while soothing concerns of deflation in the United States, it also ramped up those same fears in Europe, and complicated the long deflation battle in Japan, they said.

"What the United States has made clear is that they are not going to undertake any efforts to try to defend the currency," said Citigroup global currency strategist Robert Sinche.

"We think that is exactly appropriate in this environment," he said.

"In a world where the major concerns appear to be about deflation rather than inflation, the last thing the world economy needs is to have the United States trying to artificially tighten policy."

US Treasury Secretary John Snow described recent currency fluctuations as being "really fairly modest" during a weekend Group of Seven finance ministers in Deauville, France.

A "strong dollar" policy did not mean that the currency should be at any particular exchange rate, he said, emphasising that it incorporated other values such as confidence, or being a good medium of exchange.

The euro rose to 1.1720 dollars in late morning deals in Europe, against 1.1581 on Friday in New York.

In Japan, already battling deflation for four years, the authorities in Tokyo intervened heavily to prevent a yen appreciation. The dollar tumbled to 115.13 yen from 115.90 on Friday.

"I think for the longest period of time in effect the dollar exchange rate has been market-determined," said Moody's Investors Service chief US economist John Lonski.

Chronic deficits in US financial dealings with the outside world -- shown by a current account shortfall of more than half a billion dollars last year -- might have caught up with the currency, Lonski said.

"We are simply not able to attract as much foreign capital as we need to prevent the dollar exchange rate from moving lower. I wonder how much of this is really the product of any change in policy," he said.

Major investors in dollar-denominated assets also might have decided to diversify because of heightened geopolitical concerns, Lonski said.

In addition, the US Federal Reserve (news - web sites) had cut the key federal funds target rate to a four-decade low of 1.25 percent. Lower rates reduce the returns on US investments, eroding demand for dollars.

For now, the slide in the dollar worked in favor of the US economy, where underlying inflation fell to a 37-year low of 1.5 percent in April when compared with April 2002.

"One of the perfect antidotes for deflation is a weaker currency," Lonski said.

But "in Europe, it has the opposite effect," he added.

The appreciation of the euro, and the higher risk of deflation, might force the European Central Bank to cut rates sooner, the analyst said.

"The attack against deflation becomes globalized if the ECB decides that it has no choice but to cut rates pretty soon." The ECB holds its next meeting June 5.

In Japan, the Bank of Japan had waged a long battle in vain against deflation. "The last thing they need is a further appreciation of their currency," Lonski said.

Snow would still step in to support the dollar if the decline ran out of control, leading to a flight of funds from both the equity market and the bond market, he predicted.

"Snow made it perfectly clear, the strong dollar policy has been abandoned up until we reach that point where expecations of further dollar weakness prove to be disruptive to US financial markets," Lonski said.

Wall Street tumbled Monday. The Dow Jones industrials average of 30 top stocks plunged 171.33 points or 1.97 percent to 8,507.64 by early afternoon. But the bond market held up relatively well, Lonski said.

"If both equity and credit markets deteriorate together, chances are the dollar depreication will no longer be tolerated by the US government," the economist said.

[DoughtyOne]

Well we already know that France is taking it in the shorts. Wine sales and tourism have been impacted negitively. Sniff sniff. Cry me a river.

I agree with much of what you said. I'm not sure the trade deficit will be impacted as much as I wish it would though. $450 to $500 billion in trade deficits is complete loonacy as far as I am concerned.

[longtermmemmory]

the euro was made to knock down the dollar. Why else would people be dumping dollars?

[gettheUSoutoftheUN]

its all coming apart

[Lijahsbubbe]

That's what I'm sayin'. Not much room left.

[John123]

This is just another battle in the global trade war between Europe and the US.

Do you think the European countries will try to defend the Euro at some point if the dollar continues to be weak?

[Beck_isright]

"So if the dollar deflates, what does that mean to the purchasing power of the dollar? difference with inflation is?"

It means get out of personal debt immediately. Deflation is devasting to debtors.

[InterceptPoint]

Question for you smart guys: Isn't the rise of the Euro against the dollar more or less a result of record low interest rates in this country?

Money market accounts are now paying .95% versus 4-5% historically. Assuming that Euro based interest rates on the equivalent deposits are higher then it just makes sense that people would trade dollars for Euros and put the Euros in a bank or equivalent money market account at the higher rate. That would put selling pressure on the dollar and it would fall. That is what has been happening.

Tell me it's more complicated than this.

[John123]

Do you think Treasury Secretary John Snow's comments on the weak dollar was deliberate? So far, I have been pretty impressed with our current administration's ability to think things through. Such as 9/11, the 2 conflicts and other geopolitical events. I don't know enough about Snow and if he is just a "loose" cannon...

[Woodman]

Yes.

BTW Dollar/Yen has been as low as 98 within the last decade and no one but the currency traders even noticed. Overseas markets hate weak dollars because it works against them. Paul Volker started the non-support of the dollar and it continues with Alan Greenspan.

The truth of the matter is that the exchange rate gets set by the market, if the US tried to prop it up, it would waste a lot of money and the dollar would end up where it is now anyway. Until interest rates go up, or foreigners lower theirs to a reasonable level the dollar will stay where it is.

The true indicators of the strenght/weakness od the USD are cross currency rates without the dollar involved. EUR/JPY GBP/JPY HKD/GPB etc. look at them historically and you will get a good idea of the true value of the dollar. Also you can look at the yield curves for USD/EUR for Tom/Next through 1yr in the swap market. That will tell you the projection of interest rate differentials with exchange rates playing a factor in the price. You can also try to price leaps, but they are much more speculative.

[John123]

Tell me it's more complicated than this.

Good comments. United States' deficit is only 1.5% of its GDP while most (if not all) European countries percentage is higher. If we pursue the weak dollar policy, I think it will wreck havoc with the more liberal EU countries because they will have extreme difficulties generating enough tax revenues from the private industries to finance expensive social programs. These EU also have to meet financial criterias from Euro bankers which may be impossible. Let me know if I am wrong. :)

[oceanview]

actually, that is what Japan needs to do: tax savings, because their citizens don't consume. US citizens dont have that problem. Business investment is the problem here, businesses are not taking advantage of low rates to expand here, they are all figuring out how to pay more $$$s to their executive suites, while sending US jobs to India and China.

The Euro is now exactly where it was when it was floated I believe, it has come full circle.

[Woodman]

Yes and it will go right back to its' weakest point when the most liberal EU contries do what they will have to do.

[ambrose]

Deflation will be good for the Freepers who have been keeping cash and gold hidden under their matresses.

[A. Pole]

A "strong dollar" policy did not mean that the currency should be at any particular exchange rate, he said, emphasising that it incorporated other values such as confidence, or being a good medium of exchange.

Free market bump?

[A. Pole]

I've never really understood that kind of hubris. What can the feds really do to "defend the currency"?

Use the IMF method - austerity measures, rasing of interest rates, selling out assets to keep the exchange rate fixed.

[A. Pole]

It means get out of personal debt immediately. Deflation is devasting to debtors.

Or if you cannot, plan for bankrupcy with a good lawyer. That is if deflation is a real danger.

[AntiGuv]

A genuine free market in currency transactions would require that China permit the yuan to float on the currency exchanges, which is not the case.

[motor_racer]

Today the de facto money standard is oil. The dirty secret of the dollar is that, since oil has been exclusively priced in dollars for many years, the wealth of all the theives of the middle east has had to pass through the dollar.

The emergence of the Euro makes it possible for OPEC to consider pricing oil in another currency or (even worse) against a basket of currencies. If oil were priced in a combination of dollars, yen, and euros, OPEC would control the exchange rates, and the economies, of the world.

As a result, the rest of the world would need far fewer dollars (to support oil purchases), with the excess dollars flooding back to the US as they become useless overseas.

The dollar, and the economy, and the governments behind the notion of fiat money, all collapse like a house of cards.

What do you think would happen next?

[oceanview]

we can destroy OPEC in a heartbeat by pumping out iraq at full capacity.

[AntiGuv]

Iraq was already pumping at full capacity prior to the recently concluded war and would take an estimated 18-36 months before it could raise production to pre 1991 levels. It would take five to ten years before they could seriously threaten OPEC pricing controls - and that only if Russia didn't decide to cooperate with the cartel...