FINANCIAL TIMES - WEDNESDAY SEPTEMBER 9 1998
High-flyer hits turbulence by Barry Riley
The US dollar could only go higher, according to the consensus earlier this year. Indeed, its strength threatened to create a new Asian upset involving a Chinese devaluation.
When Robert Rubin, US Treasury secretary, ordered the sale of dollars to support the yen on June 17 the rate was 143, already down from 146 because the intervention had been rumoured. The timing was good, and the dollar fell below ¥136, but the impact was only temporary and the rate rose to 147 on August 11.
Now, though, the dollar has decisively plummeted, dropping ¥12 in eight trading days, taking the pressure off various pegged currencies, including China's.
Whatever has happened to the dollar's safe-haven credentials in only three months? The D-Mark, supposedly in line to become a victim of the Russian troubles, has appreciated by 5 per cent against the dollar in two weeks. The bolt-hole merits of the Swiss franc have once more become appreciated, and it has risen 9 per cent in two months.
Safe-haven flows out of Asia over the past year have masked the underlying weakness of the US currency. Now, however, the merest hint from Alan Greenspan, Federal Reserve chairman, of a cut in US short-term rates has accelerated the dollar's slide. The stock markets, in contrast, have seized on the prospect of lower rates with desperate enthusiasm; but the Fed may not actually have much downside flexibility.
Should we take note of neighbouring Canada, where rates rose 1 per cent on August 27? This is a different situation, and yet it is important to bear in mind that more than half of US exports go to weak currency areas in Asia, Latin America and Canada. The US balance of payments deficit is already running at an annualised $200bn and is rising fast. This has to be paid for.
One former important source of financing - foreign central bank holdings of Treasury securities - has already gone into reverse, reflecting the Asian crisis, with net sales of $80bn over the past 12 months. No matter - private sector flows from Asia into dollar bonds have doubtless meanwhile been strong. But the big foreign purchases of US equities ($66bn in 1997, and at a still higher annual rate in the first half of 1998) now look suspect too after the stock market's correction.
Temporary factors have exaggerated the dollar's recent weakness. Hedge funds beset by margin calls have been hastily unwinding their yen-carry trades, involving the purchase of yen and the corresponding sale of dollar assets; and Japanese banks may be engaged in their half-yearly exercise of repatriating foreign assets to shore up their end-September balance sheets, though it is hard to see why they should bother to pretend.
Meanwhile, Europe, which is running a comfortable balance of payments surplus, may have to adjust its plans. A moderately weak euro would have enabled the European Central Bank to edge interest rates higher and address some of the potential problems of the overheating "bubble" states such as Ireland and the Netherlands - how convenient.
A strong euro, however, might require lower rates (below today's 3.3 per cent for D-Marks) to keep the German and French economies growing, posing a threat to the regional stability of Euroland.
In the short term the dollar could rally. It is impossible, however, to imagine a longer-term solution that does not involve a sizeable interest rate premium to encourage foreigners (and US multinationals) to retain dollar liquidity. There will also have to be a rise in US savings, and a corresponding fall in consumption, to reduce the deficit.
You might describe that as a recession or, in Greenspanish, an inability to "remain an oasis of prosperity" in a distressed world.