Brad Setser

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Lucky that the dollar is in the midst of a mini-rally …

by Brad Setser
March 23, 2005

Because if the dollar was heading the other way, as the New York Times noted Wednesday morning, there is no one left at the Treasury to mind the store. Under Secretary for International Affairs John Taylor is now a lame duck. There is no Deputy Secretary. Secretary John Snow seems more of a salesman than a policy maker, and a lame duck too, for all intents and purposes.

The names of the expected nominees for Under Secretary of International Affairs and Under Secretary of Domestic Finance are well known (Tim Adams and Randal Quarles). But they have yet to be nominated, let alone confirmed.

[Update: Tim Adams’ nomination was announced today, along with the appointment of Arnold Havens as acting Deputy Secretary. I hope that a Quarles announcement follows soon. Quarles was the star of the first term Bush Treasury: even those who don’t always agree with his brief tend to think Quarles argues his case very well. Thanks to Praktike for the heads-up]

On the other hand, the absence of a confirmed Deputy Secretary or Under Secretary probably doesn’t matter much. The White House makes economic policy in the Bush Administration, not the Treasury. Tim Adams is unlikely to change that basic reality.

I confess to a bit of surprise at the strength of the dollar’s recent rally v. the euro. The (overdue) sell off in emerging markets, including some Eastern European emerging markets, seems to be playing a role, along with reassuring statements from the Hong Kong Monetary Authority. And, yes, higher US interest rates should support the dollar at the margin, particularly as weak European growth looks likely to keep European rates relatively low. But the roughly 90 bp yield pickup on 10 year Treasuries v. 10 year bunds does not strike me as all that big (the spread on two years is larger, a bit over 120 bp). The gains from the extra carry could easily be wiped out by any currency moves. Call me old fashioned, but I would want to see convincing evidence that at least the non-oil trade deficit has peaked and is heading down before making a big bet on the dollar. All the evidence, however, suggests the trade deficit is still rising.

Betting on the appreciation of the currency of a country with a growing current account deficit of more than 6% of GDP strikes me as intrinsically risky. Given the recent trajectory of oil prices, and indicators of strong US consumer demand in q1, anyone buying dollars should assume that the data releases for February and March will show an increase in the monthly trade deficit. And so long as non-oil import growth exceeds US export growth by a big margin, the deficit looks set to keep expanding during the course of the year. Slow growth in Europe may be good for US pride, but it is not good for US exports …

More on the expected 2005 US trade deficit later.


  • Posted by praktike

    Adams was announced today.

  • Posted by roger klein

    I agree: The dollar’s rise doesn’t make sense. And when something doesn’t make sense, it suggests other factors are at work. E.g., maybe the Asian central banks are playing the “punish the speculators” game that Japan’s central bank played last year. The latter worked — the yen’s rise lagged the Euro’s due to speculators’ fears of another intervention. So maybe the Chinese central bank is intervening (through one of its disguises) so that the dollar will be stronger and thus the RMB revaluation will be “unexpected.”

  • Posted by CalculatedRisk

    What if the trade deficit has been partially driven by mortgage equity withdrawal (MEW) from the housing bubble? For the last four years, MEW has exceed GDP growth in the US (it never happened in one year before). Since savings is low, wouldn’t the excess MEW flow to imports?

    Today the Mortgage Bankers announced refinance mortgages are off 60% from last year. Maybe imports will now slow too (of course GDP would also slow). This might lead to less investment by foreign CBs in dollar denominated instruments, and then higher US interest rates (and a dollar rally?).

    Just my musings …

  • Posted by Anup

    Hi Brad,

    Please use the NYT link generator for posting NYT links if you can. This allows the link to be accessible without logging in and also makes sure that the article will still be available even after a week, when normal links would lead to a NYT pay wall.


  • Posted by brad

    Praktike- thx.
    Calculated Risk — at least for now, US consumers seem to be finding other ways to keep on spending, even with higher oil prices. But no doubt there is a risk that they will hit a wall, and the virtuous circle that turns vicious housing market channel you have laid out could well play a big role in generating that wall.
    All — I highly recommend Calculated Risk’s post on this subject, and note, for the record, that his use of graphs puts me to shame.

  • Posted by CalculatedRisk

    Thanks for the comment and Welcome Back! Your paper with Nouriel Roubini started me thinking if there was a virtuous cycle. It looks like housing is starting to slow down, so it will be interesting to see if that slows down the American consumer.

    Here is my post for anyone interested:
    Housing and Trade: Virtuous Cycle about to Become Vicious?

  • Posted by jm

    The TrimTabs report on personal income as seen through withholding reported in the Treasury’s daily statements is not consistent with the downbeat reports from other sources.

  • Posted by Df

    your posts seems to dismissed the idea I suggested in a post 2-3 days ago.
    What if the rise in the dollar makes real sense ?

    the question is :
    How come the dollar movements are inversely related to the stock market movements ?
    This relation has been going on for a while. Go on any financial site, ask for a graph of the dow or SP500 and the dollar index or dollar-euro parity and you will see it.

    My answer is that it is part of the new asset economy we have.

    In a sane economy there are more goods to buy than assets. People do business, buy the things they need food, cloth, asset valuation is only a tiny part of the economy.

    In this economy asset trading as become a HUGE business. The amounts traded on financial markets far outweigh the amounts traded on the real (commercial) markets.

    Therefore all relations change.

    In a sane economy the currency value moves so as to keep equal the power of purchase in different economies. A cloth or food should cost approximately the same world wide.

    so if inflation rises faster in a country, it’s currency devalues. France 1970’s compared to germany

    In an asset economy, this does not matter anymore, what is important is that a plant, a brand, a company cost the same worldwide.

    So if asset prices rise faster in a country, its currency falls (USA 2003-2004), if the same prices fall, its currency increases.

    tell me frankly your opinion, because as I see it, it really makes sense.

  • Posted by godement

    USD-EUR up …What a surprise !

    I am amused, to say the least at both your post and the comments. I am probably quite thick, but when I look at a bilateral exchange rate, I make a point of looking at both countries involved. So in this precise case, I concentrate both on the US and the Eurozone, equally, whereas you people only seem to look at the US, in this as in other subjects.

    When I look at the US, I can’t help but notice that you have a central bank that still seems quite capable of sending a message to the market, be it that bond yields are too low or that interest rates could rise faster should the situation warrant it.

    When I look at te Eurozone, I see a central bank that has been trying to send the same message to markets for over a year: soon enough, the eurozone economy will have strenghtened and we’ll tighten policy but, oops, we thought strengthening would happen yesterday and for some reason it has not.

    Wait till the French reject the constitutional treaty. That will certainly send the EUR up, won’t it now ?

  • Posted by anne

    Then, is there an international sense that the Fed will act decisively from here? I would guess so. This may be much of the reason the Fed has been so successful for 25 years.

  • Posted by df

    I have to precise that last post of mine.
    When the stocks go down in the US, so does then the US dollar improves. Or conversely.
    And may be both move are related to rise in nominal rates from the fed.

    BUt the relationship does not apply to european stocks.

    It seems when the dollar goes down, all stock markets go up worldwide. When it goes up, all stock market go down world wide.

    May be it’s because the dollar is the ultimate world currency. What we’re seeing is asset inflation worldwide because of excessive US dolar liquidity.

    Anyway my conclusion remains, in case of a severe correction of the dow, the value of the dollar may increase.
    phrased in conventional terms :
    USA have both an asset bubble and huge commercial-financial deficits.
    Lower dollar increase the bubble, and help solve commercial financial deficits.
    And higher dollar works conversely.

    If both hit at the same time. THen what ?
    That’s my 2 cents question.
    How do you solve 2 problems with one tool.

  • Posted by MTC

    Toshihiko Fukui always tries to talk down the yen with the “if you think American fiscal policy is insane, check out Japan’s!” argument. Recently certain publications (Business Week comes to mind) offer a similar argument for a long-term decline of the Euro on the order of “if Americans are freaking out over the fiscal implications of their demographics in 2040, Europeans should be suicidally depressed over the demographics they have right now!” Perhaps some investors are taking the very, very long view and deciding that the dollar is not such a bad currency after all.

  • Posted by anne

    While individual income variance has increased these last 20 years, consumption growth appears to have remained far steadier than might be expected. The rule seems to be “do not underestimate the American consumer.”

  • Posted by anne


    Thank you. I have a difficult time being gloomy when I read of the end of Europe in 2040. However, Japan is such a stunning puzzle. How is the deflation cycle ever to be broken? Every optimistic report we have is quickly proven foolish. Wherever is consistent Japanese growth to come from?

  • Posted by knobboy

    New York Times Link Generator:

    The Economist doesn’t think much of the President’s team: “Not exactly major league”.


  • Posted by DF

    Of course europe will suffer from retirement graying population and has huge fiscal deficit.
    but it has sth lacking the USA : savings. (though those are falling here also because of the deregulation of the banking industry)
    less debt, more savings, smaller stock market bubble.
    Also please remember europe enjoys small growth.
    4% deficit in an era of small (subpotential) growth is more normal than 6% during high growth times.

    Any idea what the deficit will look like if recession hits the USA ?
    By the way, remember roach’s prediction ? durable goods order down, more unemployemnt as foreseen, yesterday it was falling realwages …

  • Posted by Dave Lewis

    One factor that can influence currency trading at this time of year is Japanese year end “book marking” and repatriation. In the past the MoF has weakened the Yen to “juice up” export earnings.

  • Posted by brad

    DF — the stock/ dollar correlation was different in the late 90s. $ up. stocks up. but no doubt recently they have often moved together in opposite directions.

    Godement — Fair point on the French referendum. I forgot about.

    But I could make the same comment about Europeans. They always seem to focus on the Eurozone’s weaknesses, not the dollar’s! Europe has a couple of key strengths, even if strong overall growth is not one of them.

    Europe’s include:

    A current account surplus, unlike the US.

    Implicitly, enough domestic savings to finance fiscal deficits domestically along with a decent level of investment.

    And in Germany’s case, quite strong export performance, again, unlike the US. Look at European exports to the US since 97 v. US exports to Europe since 97. Look at German car exports to the US since 96 (way, way up). That may be linked to the lack of domestic demand in Germany, but it is still impressive.

    If you focus on growth or interest rates, the US looks good. But if you think US growth is coming from expanding domestic demand, and thus implies a widening external deficit AND you think the external side matters, you worry. A strengthening dollar won’t help the US reduce its enormous external deficit. 05 looks to be a 6.5% of GDP current account deficit, maybe more, v. a 10% of GDP export base …

  • Posted by godement


    Europe’s current account surplus ? I’d rather say a current account basically in balance, we’re not talking x% of GDP here. Obviously, for the US to go to 6%+ current account deficit, other zones must have had a better performance, but as you well know, Europe is not really the place to look for this stellar performance.

    Investment wise, sure there is a degree of investment, but the thing that I care about is r&d expenditure which, at 2% of GDP in Europe, is way below the 3% in the US. That does not suggest to me that we are going to bridge the productivity gap anytime soon.

    Now talking about the dollar rising, I notice that the EUR topped at 0.8 against the USD a few years ago, that the USD is now 1.3, surely a substantial move by anyone’s yardstick, and that the US deficits have not decreased, but risen. Clearly, exchange rate adjustments have not done the job, the reason likely being in my view that volume effects, ie relative growth differentials, are much bigger than price effects, not to mention that continuous exchange rate adjustments transmute the J curve of old fixed exchange rates into an L curve.

    For me the solution to these disequilibria are to be found in the US itself, not in China, not in Europe. All that China and Asia do is allow these disequilibria to occur at low levels of interest rates.

    And I will repeat that when the Fed speaks, everyone knows that they are not bullshitting, whereas I am not sure the same is true of the ECB. Watch the aftermath of the stability pact at the ECB over the coming few months and tell me that the ECB has the same credibility as the Fed. No one forced the ECB to jump into this particular conflict.

  • Posted by lise

    Looking to the Economist for reasonable criticism of American politics is comical. Well, possibly not comical if we are to take the Tories seriously at this point. They love American conservatives, as long as they can complain now and again that American conservatives are not properly conservative. But, whatever could that mean. The Administration has appointed precisely the advisers wished for, with loyalty uppermost as a criteria.

  • Posted by Jesse

    Calling Dr. Ponzi, calling Dr. Ponzi….

    From the National Association of Realtors March 2005

    “The new study, based on two surveys, shows that 23 percent of all homes purchased in 2004 were for investment, while another 13 percent were vacation homes. In addition, there was a record of 2.82 million second home sales in 2004, up 16.3 percent from 2.42 million 2003. The investment-home component rose 14.4 percent to 1.80 million sales in 2004 from 1.57 million in 2003, while vacation-home sales rose 19.8 percent to 1.02 million in 2004 from 850,000 in 2003.”

  • Posted by Elaine Supkis

    Does the EU have a much higher industrial base than the USA?

    What if we exclude military businesses here (which are evidently,as of this year, the majority)?

    Europe is selling stuff to the USA and we are selling them what?

    Ditto China and Japan. What are we selling them?

    The ships carrying goods from the world depart our shores with precious few industrial goods. Americans have “jobs” but few are “value added” jobs. Walmart manufactures nothing at all.

  • Posted by Steve McQueen

    re: European economy, it reminds me a bit like looking for LBO targets. As it stands, we’re not looking at a rocketship economy. But where there’s ample room for improvement, deals can be done. Leverage can be added (especially in the current rate environment) whereas USA does not possess this form of reserve. R&D investment can be increased. Compare with the current issues in US pharma, telecom, internet… Working culture can be improved (i.e. French workweek story), whereas US efficiency metrics seem to have topped out. Private equity has been more active in EU than USA, so I am not the only one thinking this way – and when the big economic actors appear on the stage, markets move.

  • Posted by Ryan Darwish

    “when the Fed speaks, everyone knows that they are not bullshitting”


    In my opinion this is a bit of an overstatement. I, for one, am coming to the view that the Fed is more like the Wizard of Oz, sitting enfeebled behind the curtain of the aura of power. They may be more masterful as using the sophistry of political rhetoric in thier manipulations, but it is starting to appear to me that they may be losing their ability to do much other than talk.

  • Posted by Justin

    “The ships carrying goods from the world depart our shores with precious few industrial goods. Americans have “jobs” but few are “value added” jobs. Walmart manufactures nothing at all.”

    basic chemicals, pharmeceuticals, aerospace, computers, semi conductors, machinery, medical equipment, motor vehicles are some of the big ones

  • Posted by jade

    Current dollar strengthening due in part to hedge funds unwinding their positions. Several borrowed $ to buy higher yielding assets in other countries. Now getting back into $ as recent inflation stats are spooking everyone and people are unsure how long Fed can remain “measured.”

  • Posted by anne


    Please develop your thought further. What are the effects of hedge funds unwinding leveraged positions? Why has it taken 3 years for Berkshire Hathaway to unwind derivative positions gained in buying a reinsurance business?

  • Posted by anne

    What we are assuming then is hedge funds that owe dollars against short term adjustable notes will be selling foreign securities and buying dollars to repay the loans so that they do not get caught by a 50 basis point move by the Fed.

    The markets hoever are awfully calm. What about long term American bonds?

  • Posted by brad

    jade — i had similar suspicions but no evidence! However, why is this generating a move in the $/ euro rather than say the $/ brazilian real or $/ Turkish lira? there presumably would need to be a move out of higher yielding Euro denominated securities (funded with $ borrowing).

    Godemont — throw in Norway and Sweden and Switzerland along with the Eurozone, and the IMF forecast that it had a small current account surplus in 04. But certainly nothing like Asia or the middle east. Agreed. That said, some money from the middle east is invested in europe, requiring offsetting outflows from the US to europe to make the global current account add up. Still, europe is not big net borrowing, even if it not a huge net lender either.

    Fully agree that US deficits are made in the USA, with a bit of Asian help (without asian financing, interest rates would be higher and US demand growth slower). And yeah, there has been a big euro/ $ adjustment. But I think the overall adjustment in the US Current account requires further dollar adjustment, though not obviously further adjustment against europe. If Asia appreciates and the Euro depreciates, the net effect on the US of the Asian appreciation would be reduced.

    Re: J curves. Not sure we have seen much of a J curve yet. the price increase in US imports, including US imports from Europe, has been small. Compressed profit margins and hedging. Greenspan says the increase will come with a lag. What the euro/$ adjustment has done is support US export growth, which was a lot better in 04 than in the past. Not just exports to europe, but exports to third party markets. GE v. Siemans in Asia. Boeing v. Airbus everywhere. etc. At the end of the day, cutting into a trade deficit that is so large v. the US export base will take expenditure switching via the XR channel to support export growth, even if the impact on import values is modest (and right now the impact on import volumes seems non-existant), and expenditure reduction. It takes both. The euro/$ adjustment did not cut into the financing of the US (mostly from asia in any case, and europe still seems to be buying US corp. debt), and thus did not trigger any expenditure reduction … so that part still remains.

    At least that is my take.

  • Posted by Movie Guy

    Is the U.S. dollar expected to climb in relation to other global currencies as the U.S. interest rates climb?

    Is this the bottom line?

  • Posted by Yusef Asabiyah

    I think the bottom line is that our economic policies are unsustainable and can’t continue indefinitely.

    While I thought that it was terrific to see some recognition given to the weaknesses of the euro and the european union in this discussion, I don’t think the weaknesses of other currencies or economies can serve to take the heat off the US for very long.

    While it may have been temporarily comforting for some to observe many other people paying exhorbitant prices for earningless dot.coms, those comparisons served to damage better judgment and turn large numbers of rational investors into an unthinking mob.

  • Posted by James Miller

    Dollar revives a bit, but why? Here is a likely cause.
    Repeated polls show that the French may well reject the EU constitution in the public referendum that will be held on May 29. The constitution must be ratified by all 25 nations in the EU to go into effect. Since Jacques Chirac is a strong supporter of and contributor to this crucial document, and a previous head of state for France wrote a great deal of thing, it is not hard to see that the EU will be thrown into a state of great confusion if France itself rejects it. One can talk a long time about the not-so-simple reasons for the current negative polls in France, but, in my view, the current dollar move relates more to uncertainty about the future of political and economic unity in the EU than to any great resurgence of affection for the old U.S. greenback. The political line at the moment here in France among those who would like to see the constitution adopted is that the constitution would have acted as a bulwark to prevent further economic colonization of Western Europe by MacWorld (or perhaps WalmartWorld, depending on which of these giants are higher on your personal hate list), but a defeat of the constitution is widely seen as damaging to the competitiveness of European economies.

  • Posted by Don Hatfield

    Tim Adams was my roommate in College and still a friend. He will do a great job as Under Secretary for International Affairs. He thinks for himself and will change policy where needed.

  • Posted by brad

    don — hope you are right. usually the under secretary does not have total freedom to change policy direction tho, and i tend to think some big changes in direction may be needed.

    p.s. — not many people will see your comment here, since not many people look at old threads (I have special powers as the moderator — i can see the most recent comment on any page). if you wanted more attention, you could certainly get it my adding this comment to the current active strand. up to you.

  • Posted by Pinar Ozayranci

    Dear Sir,
    I am a student of ”MBA(master in business administration).
    I read you from internet.I have a homework to finish school.

    The name of my homework is
    ”The effects of dollar/euro parity to foreign companies in Turkey”.Aso I’m working for a Swedish company as business administrator.The biggest problem of our company is; ”Because of unstable exchange rates,our competition power is decreasing.For example;USD/EUR parity was 0.9 last of 2002.At present 1.2.We sell our products in Euro.We can’t compete against American companies.Even we decrease our profit,if an American company participates to award,it is impossible that we can win.”If I investigate that subject;it will be useful for me and our company.Also I have to research the ways to protect from that situation.
    The title may be like that”The affects of unstable exchange rates on foreign companies”
    And may be I can find the solution ex.hedging system.

    Could you please help me about this subject?The web sites ex.
    What are your opinions?Thanks alot.

    Best regards,
    Pinar Ozayranci