Global Agenda: The ugly parade

Why should anyone hold dollars? The answer, in essence, is that the alternatives are even worse.

By PINCHAS LANDAU
The financial markets have recently suffered another bout of what might be called “anti-American sentiment.”
The relative strength of this sentiment is best tracked via one of two methods: either using the dollar/ euro rate, because these are the most widely traded currency pair, or by using a dollar “index,” which is composed of several leading currencies.
Last week, in particular, the dollar seemed to be virtually in free fall. Against the euro it dropped as low as 1.385 and looked intent on crossing the 1.40 mark on the way to its most recent low-point versus the euro, of almost 1.43 in early November. The most frequently cited dollar index, which is comprised of six other currencies, was even weaker, falling to as low as 76.88 – within sight of its low levels of last November, when it almost reached 75.
This decline, which had been under way for several weeks and climaxed in the first half of last week, was accompanied by a renewed chorus of gloom and doom about the dollar and its prospects, in both mainstream media and blogosphere outlets. The main theme was that the monetary policy being pursued by US Federal Reserve Chairman Ben Bernanke is explicitly aimed at creating higher inflation and therefore strongly implies that the dollar will fall.
Furthermore, this policy of buying government bonds in the market, which is effectively printing money, is creating a flood of liquidity around the world, which is a key factor pushing up both equity prices and, especially, commodity prices. The latter, notably those for grains, sugar and other food stuffs, are the cause of the rising inflation now apparent in many emerging economies.
The bottom line of all these analyses was that so long as Bernanke sticks to his policies – which most of the commentators regard as damaging, if not disastrous, for the US and the world – the decline in the dollar would continue. Indeed, quite a few warned that if the decline continued, it might well turn into a rout, as confidence would collapse and panic selling of US Treasuries by foreigners would ensue.
However, as often happens in the markets, just when it seems that a trend is unstoppable, it turns round. Thus it was that in the second half of last week, especially on Friday, the dollar reversed course and climbed strongly. Disaster had thus been averted or, at the least, postponed.
That set up this week to be potentially very interesting: Would the dollar continue climbing , or would it fall back? In the event, very little has happened – which is to say that the foreign-exchange market was relatively quiet, certainly much more so than in the previous week.
From the perspective of technical analysis, all options remain open. But in the current situation, it is more interesting to consider the fundamentals behind the foreign- exchange market. On this basis, the rationale for selling the dollar is very clear: American monetary policy is undermining the country’s currency, while the huge budget deficit keeps growing, swelling the country’s debt burden accordingly.
Why should anyone hold dollars? The answer, in essence, is that the alternatives are even worse. The primary alternative is the euro, but the problems of the common currency and the disparities between the countries that use it are now so well-known that most people are convinced the euro zone will break up before long.
How that will happen and what will replace the euro are open questions, but they considerably dampen enthusiasm toward holding the euro.
Other European currencies outside the euro zone, notably the Swiss franc but also the Norwegian and Swedish kroner, are more attractive – except that the economic problems of the euro zone inevitably spill over and affect them. The result is that while these currencies may be preferable to the euro, they cannot be divorced from its problems, and they tend to trade in the same direction as the euro, rising and falling against the dollar along with it, albeit not always to the same extent.
That leaves the Japanese yen as the other major currency traded on a large scale (the Chinese yuan is not freely traded). But Japan has its own basin-full of problems, starting with a level of indebtedness that makes even the Americans look solid. Furthermore, the interest rate on the yen is even lower than that on the dollar, making it unattractive to hold. Finally, it is clear that the Japanese authorities will intervene in the market to prevent any further significant appreciation in the yen, which is already near record levels against both the dollar and euro.
This is the “ugly parade” of the world’s leading currencies, with investors constantly trying to figure out which one is worse and changing their positions accordingly.
The dollar has recently been out of favor, but that can change again as it has in the past –more likely because of something negative out of Europe than thanks to something positive out of America.
landaup@netvision.net.il