I have been of the unwavering belief that the US dollar is a flawed currency. Add the US government's apparent lack of concern with towering deficits to the Fed's willingness to reduce policy rates to virtually nothing and you have a tailor-made recipe for value destruction. Due to what I call "special FX"--foreign exchange moves oblivious to fundamentals--the dollar recently mounted a rally against virtually all currencies save for the Japanese yen. Various things have been said to contribute to "special FX" including the repatriation of foreign investments, growing risk aversion, and the movement to supposedly "safe" assets such as Treasuries. Nevertheless, the recent Fed move to reduce its policy rate to zilch has once again revealed American indifference to debasing its currency.
The implications of the American iteration of ZIRP (zero interest rate policy) are tremendous. First, the US cannot without hypocrisy claim that countries such as China are engaging in mercantilist practices when America has thrown down the gauntlet in this regard with its unprecedented interest rate cut. Yes, it would be the pot calling the kettle black with regard to competitive devaluation. Second, intelligent investors should be cautious about leaving their money in greenbacks. True, other countries are likely to follow suit in cutting rates, but the Fed has signalled that it will resort to more extreme measures such as buying long-term Treasuries and junky assets to get cash flowing once again--not a good sign at all. Bernanke's helicopter drops cash again and again.
Third, I will grind my axe once more in saying that those calling for dollar strength against all apparent reason have been proven wrong and will likely be proven wrong in the future. Earlier on, I featured an op-ed by David Hale in TIME suggesting that the dollar will benefit because, as bad as things are in America, they're even worse elsewhere:
The message to dollar bears is clear: the grimmer the headlines are, the moreHowever, this is not the most extreme of views yet. During the recent bout of dollar strength, a whole bunch of commentators were calling for the common currency to fall to parity with the dollar, 1:1. I've been saving them among my del.icio.us bookmarks due to their sheer ridiculousness in anticipation of this moment. Indeed, I labeled them with something unprintable on this family-oriented blog. Let us begin with State Street Global Markets:
misleading they can be. Selling the dollar short because of the financial crisis
is not a sure bet. All economic news is relative, and right now the news is bad
all over the world. Over the next several months, the greenback could even begin
to look like a safe harbor in the midst of the global economic storm.
The dollar will rise to parity with the euro in 2009 as the European Central
Bank cuts interest rates and market volatility prompts U.S. investors to
repatriate funds and hedge their currency risks, State Street Global Markets
``One of the calls we have been making recently is that there's a very strong possibility that euro-dollar could reach parity,'' Carlin Doyle, a currency strategist in London at State Street Global Markets, said in a telephone interview today.
"European banks account for about three-quarters of the $4.7 trillion of
cross-border loans to emerging markets," said Marc Chandler, global head of
currency strategy at Brown Brothers Harriman in New York. "Despite the
finger-pointing from Europe as to how irresponsible the U.S. has been, there is
a crisis brewing of their own making that may turn out to more destabilizing
than the U.S. subprime fiasco."
"We see the risk of hitting parity by the beginning of 2009," said Sebastien
Galy, a currency strategist at BNP Paribas in New York, referring to the euro
and the dollar. "The downside risk to the euro continues to be the financial and
economic repercussions of the credit crunch traveling through Eastern Europe." [Why should the euro be adversely affected by the fate of non-euro adopting countries?]
Stephen Jen, global head of currency research at Morgan Stanley in London, said European banks were five times as exposed to emerging markets as their American or Japanese counterparts. Bank exposure to emerging markets amounts to about 21 percent of European gross domestic product.
That compares with only 4 percent of U.S. GDP for American banks and 5 percent of the Japanese economy for Japanese banks, a recent Morgan Stanley study showed,
citing data from the Bank for International Settlements. "The emerging market downturn will be the second epicenter of the global crisis, with feedback effects hitting euroland and the U.K. particularly hard," Jen said.
12/18 UPDATE: Stephen Jen on Morgan Stanley now says "This is a market movement that has surprised me...it is so rapid and so large, and something very real."I sure hope Jen's well-documented dollar-loving proclivities didn't cost his employer even more losses.