FYI | Nov 06 2007
By Greg Peel
In the last thirty years, all but one of the significant trend changes in the direction of the US dollar have been caused not by natural economic forces but by multilateral currency intervention, Morgan Stanley economists Stephen Jens and Charles St Arnaud point out. The way things are shaping up, another such intervention is not beyond the realms.
The two believe the dollar is likely to weaken further from here, despite it already being at historical lows on an index basis since the index’s inception in 1973. If that is the case, then intervention can’t be ruled out. The decline may continue “unless it’s stopped”. Weakness in the dollar is a result of a slowing US economy which has lead to lower interest rates and a desire from investors to diversify into developing countries.
America lose its hegemony? We simply can’t have that.
There has not been a currency intervention during the current president’s reign and given US Treasury secretary Hank Paulson is ex-Goldmans, it’s no surprise he advocates a currency set by market forces. However, he has also echoed the words of predecessors in saying a strong dollar is in America’s interest.
From the point of view of the other major players – Europe and Japan – the same is true. The euro has appreciated 13% against the dollar in the past year and threatens to undermine the European union’s export industry which has just started to hit its straps again. In Japan’s case, while it has never been happy being a source of cheap funds to the world via the carry trade, a swift and painful unwinding of those positions could see the yen skyrocket as it has in the past. That is not desirable either. Policy makers can intervene in currency markets by arranging purchases and sales of foreign exchange.
At present, the US has been in a monetary policy tightening phase while Europe has been raising and Japan treading water. If these trends stop, and the dollar keeps falling, then it may be time to intervene, Jens and St Arnaud warn. This is unlikely to happen while the euro remains under US$1.50 (it has hit US$1.45) and the dollar stays above 100 yen.
The European Central Bank bought euros back in 2000 as the euro slipped below US$0.90 only a year after its launch. Japan bought yen in 1998 when it had fallen to 146.78 to the dollar, but sold yen in 2004.
Gold traders be warned.
