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Deja vu all over again (dollar falls v. the euro when Americans are on vacation edition)

by Brad Setser
November 24, 2006

Maybe it is just me, but Thankgiving 2006 is starting to feel a bit like the period after Christmas in 2004.   Both periods saw sharp falls in the dollar in thin markets.  1.31 isn’t 1.36.  But, in a (almost) no volatility world, a sudden move to 1.31 certainly generated headlines

I certainly don’t know if the dollar will rebound when more normal market conditions return next week.    Some certainly think so.  But there are no shortage of reasons why the dollar could stabilize below 1.30 – a slowing US economy, smaller growth (and interest rate) differentials between the US and Europe and that large (and still rising) US current account deficit.  BNP Paribas seems to be among the structural dollar bears:

“To dismiss this as a technical correction is to overlook the structural reasons why the U.S. dollar is having a very hard time these days,” said Hans Redeker, global head of currency strategy at BNP Paribas

Some carry traders somewhere must be nervous.   At the Euromoney conference in early November, pretty much everyone on the program seemed to expect that the low volatility environment that makes carry trades attractive would continue.

High carry strategies (at least strategies that involved borrowing low-yielding G-10 currencies to invest in high yielding G-10 currencies) have made money nine of the last ten years.  1998 is the only exception.   That was one thing I learned at the Euromoney conference.

Most expected “high carry” strategies to continue to do very well – not just in 2006, but also in 2007.    I don’t think borrowing euros to buy dollars has been a popular carry trade.  There isn’t much carry relative to the risks – particularly as the euro has rallied against the dollar this year despite somewhat lower eurozone rates.  But borrowing yen to buy dollars certainly has been a reasonably popular high-carry strategy.    And the yen joined the euro in this week's move, even if it doesn't seem to have moved as much on Friday. 

For all the parallels with 2004, though, there are no shortages of differences between the fall of 2004 and the fall of 2006.

Here are the ones that stand out to me. 

  1. China is far more exposed to a big fall in the dollar now.    China has twice as many reserves today as it had two years ago.   It may not quite have twice as many dollar reserves as it had two years ago (I suspect it diversified a bit during the dollar’s rally v. the euro in 2005), it still has a lot more dollars than it had a few years ago.   China’s dollar reserves are almost north of 25% of China’s GDP ($700b v. $2.6 trillion or so).  
  2. There was an active debate inside China about China’s potential (over) exposure to the dollar even before the dollar’s recent slide.   But it isn’t clear to me if that has generated a consensus on what to do.  China has already tried most of the easy options.    Allow a bit more flexibility.   Done that. Keep Chinese interest rates below US rates.  Done that. Make sure the RMB’s appreciation is less than predicted in the forward market.   Done that. Loosen controls on capital outflows.  Done that.  Increasingly allow firms to keep their dollar export proceeds on deposit in the banking system in dollars rather than convert them into RMB.  Done that. Convince the banks to hold the funds raised in their IPOs offshore.  Done that …. despite all these efforts, China’s reserves are still rising by $20b or so a month, and no doubt it dollar holdings are rising fast.   The RMB’s slide v. the euro won’t help China’s efforts to rebalance its economy away from exports either. 
  3. The oil exporters are much more exposed to falls in the dollar than in 2004.    They have stuffed a tremendous number of dollars away over the past few years.   Even those that have shifted their portfolios toward euros (Russia) have more dollars than they did a few years ago – simply because they have a lot more money to invest in international markets.   The Saudis presumably have even more dollar exposure …
  4. GCC has even less need for a weaker currency right now than in 2004.   Back in 2004, I think most of the oil exporters were expecting oil to fall back and budgeting very, very conservatively.   The GCC still has a huge cushion between budgeted spending (inlcuding spending on investment projects) and export revenues.  But there also is a fair amount of additional domestic spending (including spending on ‘investment projects”) in the pipeline.  Indeed rising spending — including a surge in construction — led GCC inflation to pick up even before the GCC currencies joined the dollar's most recent slide. 
  5. But if China and the Gulf are more exposed to a fall in the dollar than they used to be, the same cannot really be said of the rest of Asia.  In late 2004, most emerging Asian economies had been intervening almost non-stop for several years.     The dollar’s 2005 rally let them get out of the market (and no doubt helped many diversify).  They were active in the market sporadically in 2006 (including, I would bet, on Thursday and Friday), but they have been intervening on a sustained basis.     
  6. As Stephen Jen notes in revising his euro/ dollar forecast for the end of 2006, Europe’s economy looks healthier now than it did in 2004.  The euro’s rally v. the dollar in late 2004 came in the face of rather sluggish European growth.   Somewhat ironically, the euro area economy picked up in 2005 amid a big bout of euro-pessimism in the currency markets (and all sorts of political angst).    And no doubt some European finance ministers are worried that the euro’s current strength will trigger a renewed bit of sluggishness in the eurozone.    Think the RMB is weak v the dollar?  Look at the RMB/ Euro …
  7. The US needs rather more financing than it did in 2004.   The US current account deficit in q3 2006 is likely to be around $900b annualized … and unless the US starts cutting rates, I suspect the current account deficit will continue to rise in 2007 even if the trade deficit stabilizes or falls, thanks to a rapidly rising interest bill. 
  8. One thing though probably hasn’t changed much.  The US net international investment position — the gap between the dollar value of US external liabilities (FDI in the US as well as US borrowing from the world) and US investment abroad (inlcuding US lending to the world).   Stock markets outside the US generally have done well again this year.   And the euro’s slide increase the dollar value of US investment in Europe.   The rising value of US external assets should help to offset all the debt the US is taking on.  Nothing beats borrowing against the rising value of your external assets.

One of the features of the international financial system over the past few years is that any fall in the dollar has been met by both an increase in the overall pace of reserve growth (countries that peg to the dollar have followed the dollar down, and many countries have intervened rather than allow their currencies to move up) and an increase in the share of that reserve growth that is held in dollars.   So a weaker dollar generally has meant more rapid growth in central bank dollar reserves: central banks have financed the US when the markets don’t want to.

At the end of 2004, I suspect some central banks had rather more dollars than they wanted.    Many were able to shift in euros over the course of 2005 – that was one side effect of the Homeland investment act and the (failed) referendum on the new European constitution. 

Other central banks though continued to pile up the dollars.  China and the oil exporters most notably.

If the dollar’s current slide continues, those countries face a set of increasingly difficult choices. 

China’s current (not-a-real basket) peg implies that it would need to pick up its dollar reserve accumulation to keep the RMB from rising against the dollar, even as its central bank talks of diversification.

The GCC countries would be faced with a similar set of choices – their currencies are depreciating in real terms as well.     That will only add to (strong) inflationary pressures in the most rapidly growing GCC countries – and force the GCC countries to choose between more sterilization (which likely means scaling back spending plans), higher inflation (and real appreciation from faster price rises than in the US) or a revaluation (and a real appreciation from a nominal appreciation). 

And emerging Asian economies (from India to Korea) could have to choose between allowing their currencies to appreciate (or, for some, appreciate more) against the dollar and renewed large-scale intervention.

No doubt, there are lots of folks hoping the dollar rebounds on Monday.  So long as the dollar stays in its recent ranges, many key actors can continue to postpone some increasingly difficult choices.  But if the dollar slides, some have to choose whether or not to join the dollar on its way down .. and others have to choose whether or not to join the euro and the pound on the way up.

39 Comments

  • Posted by touche

    Our foreign lenders are at the end of their rope. US consumers have already taken on more debt than they can handle. The dollar has become the hot potato.

  • Posted by Guest

    Or is it that all the senior traders were on vacation on Friday?

  • Posted by Guest

    The FED is for a “strong dollar” policy only for superficial public consumption. In fact they would be delighted to see the dollar drop, especially vs. the yuan. Now if they could only get the Chinese from pegging to the dollar. LOL.

  • Posted by Anonymous

    Brad- It may be wise to make the connection with the G20 of last week end?

  • Posted by Emmanuel

    I also like the thinner trading example, so if I may -

    9. The US dollar is prone to larger movements during holiday seasons like Thanksgiving 2006 and Christmas 2004. Stop-loss levels are more readily breached due to a lesser number of folks reining in dollar weakness.

    What the heck, let me throw in a bit of fundamental-speak to spare you all from my “random walk” shtick. I posted this as well on the Roubini site, but it’s worth noting that they’ve apparently been cranking out dollars at a furious pace since they discontinued M3. So, there may be truth in the “helicopter pilot” designation for the current Fed Chairman after all -

    10. Ever since the discontinuance of M3, the dollar printing presses have been running overtime. To no one’s surprise, dropping loads of greenbacks from the skies tends to lessen the value of the dollar.

  • Posted by bsetser

    Not sure what the G-20 connection is … US sent Kimmit (Deputy Secretary), who isn’t Paulson. G-20 is not (yet) a mechanism for action — tis very much a talking shop. Paulson’s return trip to China strikes me as more important.

    the FEd doesn’t have a strong dollar policy. The fed has US price stability/ US economic stability policy. The Fed has made it clear over and over again that it will not direct monetary policy toward maintaining the dollar’s external value. No one should expect that it does. The Treasury does have a strong dollar policy — but agree that it is mostly in name. It would be hard for the US to advocate a weak dollar. And the US hasn’t been doing anything one way or another to influence the dollar’s value … and it also clearly has a “stronger” RMB policy and would like China to intervene less, even if that means that the dollar would fall v. the rMB.

    But no one should ever expect the uS to direct its macro policies toward maintaining the dollar’s value. the uS has never made such a commitment. and one of the key features of BW2 is that it hasn’t imposed any constraints on the US — other folks have unconditionally bought dollars for their reserves.

    M3 isn’t something the fed directly controls. the various things it does control do seem to be tightening. If I was looking for the source of all the “liquidity” in the system, I would look to all the dollars central banks (notably in oil exporters) are putting on deposit these days.

  • Posted by Emmanuel

    Good point about the oil exporters and the money multiplier effect.

    Still, do take a look at the increase in repurchase agreements conducted by the Fed during the past year in the second chart from the link above. Treasury has been in on the action as well. Idiaminomics is alive and well–when in doubt, just print more money. I have a feeling that this foolishness will all end very badly.

  • Posted by HZ

    “the FEd doesn’t have a strong dollar policy. The fed has US price stability/ US economic stability policy.”

    That is very true, but what is the effect of a sudden collapse of the external value of dollar? And does the Fed have any policy tool to counteract that? Even if imported manufactured goods are not that big a component of price indices, a large drop of the dollar would surely quickly lead to large spike in oil/commodity prices in dollar terms?
    It is interesting that the Chinese officials argue that USD is overvalued while US say RMB is undervalued. While they seem to agree the difference is subtle. China does not want to be the only one appreciating — it wants currencies of competing economies to appreciate in tandem.

    “M3 isn’t something the fed directly controls. the various things it does control do seem to be tightening.”

    True until very recently. M0/M1 are creeping up again. But then the Fed does not control those either. It just controls the overnight rate :-)

  • Posted by Guest

    Certainly the dollar is doomed to fall down against most currencies. Nevertheless ECB monetary policy is not as tight as one could desire as monetary agregates have been increasing above GDP grothw rate durring the last 5 years. So large amounts of liquidity that created all kind of bubbles are the irresponsasibilty of all central banks. To me I´d rather to have gold in the next years that fiat money.

  • Posted by HZ

    Krugman (via Econbrowser) http://www.econ.princeton.edu/seminars/WEEKLY%20SEMINAR%20SCHEDULE/SPRING_05-06/April_24/Krugman.pdf is very illuminating. He argues that dollar plunge’s macroeconomic effect may not be severe.

  • Posted by Anonymous

    Guys stop ventilating…
    If the $ declines to 1.40 vs euro and Y110 or Y105 that would hardly be worth even reporting.
    Are those 10 cents so big?

  • Posted by Guest

    re: “China… wants currencies of competing economies to appreciate in tandem.”

    “…Over the last few weeks, the Bank of Korea has been busy intervening in the FX market, buying US$ and selling Won in an effort to stem the rise of the currency. In addition, both the Bank of Korea and the Finance Ministry have intervened verbally over the last few days, labelling the Won as excessively overvalued… And yet, despite government intervention, the Won continues to power ahead… Whenever something doesn’t add up in the markets, like good conspiracy theorists, we tend to look at central banks. Could the strength of the Won be a result of the much publicized diversification of reserves? After all, the PBoC and the BoJ have all the incentives in world to push up the Won and put the Korean competition out of business. Failing that, we are really struggling to think of who is buying the Won in a world full of willing sellers…” Louis-Vincent Gave, GaveKal, Nov. 24/06

  • Posted by bsetser

    1.40 v euro = big. Over 50% move (I think) since early 02, record low, out of historic norms, etc.

    Y 105 not so big (yen was around 100 …).

    Big appreciation of europe v. Asia = huge story. One that is remaking the world — China is now as big a supplier to Europe as to the US. That is new.

    A 10% depreciation of the RMB/ GCC (the big surplus regions in the world economy) adds to the strains on their $ pegs, so it is a story there as well.

    Re: the Won … the Koreans generally have allowed it to move up, unlike many others … so I can see why there might be non-central bank demand.

    More generally, Non-China Asian intervention is actually highly correlated with the euro/$ (a measure of pressure on the $) so I am hardly surprised.

    I would not be surprised if the won is also emerging as an alternative reserve currency. China has said it holds won. I would be surprised if the BOJ was diversifying into won, but, well, I guess you never know. Of course, more than one can play this game. I woudl not be surprised if the Bank of Korea has used the period when it was out of the $/ KRW market to shift some of its reserves out of the $, and it thus has less $ exposure than the PBoC. Pick your poison.

    In any case, I though Gavekal was all about platform companies that outsourced production to China … if the PBoC is pushing up the won, why wouldn’t Samsung join GE and Apple and a bunch of others in subcontracting manufacturing out? From the Gavekal point of view, where is the problem? Korea can join the US as an HQ for platform companies, run a current account deficit and rely on ongoing Chinese financing to cover its (cheap) imports …

  • Posted by madphycom

    Anon -
    “If the $ declines to 1.40 vs euro and Y110 or Y105 that would hardly be worth even reporting.
    Are those 10 cents so big?”

    Yes – 1.30 has been a level that the ECB has tried to maintain, and 115 is about where the BOJ thinks about stepping in. At least, that’s been the recent history.

  • Posted by tmcgee

    Dollar assets hard to diversify – China FX official
    Sat Nov 25, 2006 2:07 PM GMT
    BEIJING (Reuters) – Countries holding large stockpiles of foreign exchange reserves face problems diversifying their holdings away from dollar-denominated assets because of the potential market reaction to any such move, a senior Chinese forex official said on Saturday.

    http://za.today.reuters.com/news/newsArticle.aspx?type=businessNews&storyID=2006-11-25T120745Z_01_WAN543651_RTRIDST_0_OZABS-FINANCIAL-CHINA-RESERVES-20061125.XML

  • Posted by Guest

    Thought Jen summed it up nicely with this:

    “Since the US offers not only the most liquid sovereign debt market but also the most liquid risky asset markets (corporate bonds, equities and other higher-risk assets), the dollar cannot collapse. Financing the US C/A deficit does not require foreigners ‘doing the Americans a favor’, and the notion that non-US citizens could suddenly stop investing in the US is greatly mistaken…”

  • Posted by Guest

    There seems to be 2 camps in the FX world. With what seems to be the diversificaiton of carry currencies, including the transformation and introduction of the Swiss franc, perhaps there are sufficient checks and balances on (very) extreme moves that those who thrive on volatility can co-exist with the carry traders.

    As for the commmodity currencies, noticed a remark on 4cast which, if I understood, inferred that Australia is now so foreign owned that shareholders cannot afford to allow a massive depreciation of the currency. More generally that slowdown or not, competition for commodities should keep M&A moving at a pace that will limit downside in the shortrun no matter what happens to commodity prices. Might help explain what may be a sudden change in the negative sentiment towards CAD.

  • Posted by bsetser

    Well, I disagree slightly with Jen … treasuries may be more liquid than any sovereign european debt market (read in the BIS that no one contributes more to the stock of euro denominated sovereign issues than Italy … ) and the US may have the most liquid sort-of-risky asset market, but most alternative assets are not denominated the currency of a country with a huge and growing trade and transfers deficit. The currency risk is especially high with the $. Especially for the emerging economies now propping the $ up. If you are assessing the risk of holding $ (with a higher yield than euros) or euros if you want to buy euros at some point in the future, well, the risks may be close to balance (or will be if the $ falls a bit more). But if you are concerned about returns in your local currency, I don’t quite see why holding either $ or euros makes sense .. which is why I think emerging market central banks are doing the US a favor.

  • Posted by Guest

    The US Dollar drops to:

    - 19-month lows against the euro at 1.31, down 2.5% on the month and 10.6% on the year

    - 3 month lows against the yen at 115.62, down 1.1% on the month and 2.0% on the year.

    - 23-month lows against sterling at 1.9348, down 1.4% on the month and 12.4% on the – year.

    - 5-month lows against the Swiss franc at 1.2072, down 2.6% on the month and 8% on the year.

  • Posted by Dave Chiang

    Hi Brad,

    Despite the rhetoric, foreign Central Bank officials are likely intervene once the momentum in dollar selling triggers some key support levels. Central Banks are political organizations that respond to political pressure from their respective governments and corporations. If the Japanese currency were to trade at 80 yen to the dollar, corporate profits at Toyota and Honda would be crushed by the currency exchange. Moreover, the US government would find it increasingly difficult to finance the military defense of Japanese sea trade transport routes. The Central Bank of Japan will respond with a flood of yen liquidity to support the Japanese government’s massive purchase of US Treasury bonds and mortgage backed debt securities. In the era of US Dollar hegemony, the yen and Euro are merely derivatives of the US Dollar. The purchasing power of every fiat currency will decline. The world’s only legitimate money is Gold which cannot be printed in reckless abandon on electronic printing presses.

    Regards,

  • Posted by bsetser

    D. Chiang — I agree with the first 1/2 of your point; indeed, lots of central banks presumably were in the market last week in one way or another. Korea, India and so on. the BoJ would no doubt step back in if the yen moved too far too fast; 115 tho is nothing for them to worry about. They were worried about yen weakness at 120.

    Things don’t move in a straight line … and Asian central banks that have been sporadic players in the market are likely to become sustained participants should the dollar go through a truly difficult period. If the difficult period is sustained tho, they face a real choice — finance the US for an extended period a la the PBoC, or change policies.

  • Posted by Guestimate

    @DC, @bsester

    I think you (DC) are right on that. I even wonder if China takes the dollars and buys gold. Would that be possible, buying a lot of dollars, and using them to buy gold, without putting in Danger BT2 (@bsester)?

    How big is the gold exchange in China, would it be possible for China to buy more than 50 tonnes of Gold YoY without a major notice in the press? Is gold output per year at 2500 tonnes?

    I see the Euro at dangerous highs, It almost has to fall against Latin American, Asian and Canadian Currencies.

  • Posted by Guest

    I don’t agree entirely with Jen – or that piece – but even if foreigners are ‘doing the Americans a favor’, presumably they have very good reasons and that good will, hugely important asset, is translated into a component of brand value of sorts, which is unique to the USD.

  • Posted by Anonymous

    Eur is not strong. You are all plain wrong.
    The BoE effective exchange rate shows it.
    The EUR averaged 89 durig the 1980s and 93 during the 1990s. It is curently standing at 94 and Germany the exports pwerhouse is having a laugh.
    At the time of the launch the REER EUR printed 93.
    You are misleading readers when you measure euro’s rally from its weakest point. There were one off factors at play.
    The German exporters lobby BGA forecast (!) is for 1.40 mid 2007.
    The bilateral eur vs $ would have to get to 1.45/1.50 to start having a negative impact.
    The reality is that the REER EUR is WEAK compared with historical precedents.

  • Posted by Guest

    “Gold fell from its highest in nine days on concern the International Monetary Fund may sell some of its $64.7 billion in gold reserves after some of the fund’s executive directors recommended a sale…” http://www.bloomberg.com/apps/news?pid=20601100&sid=a3lTn_cVQ35c&refer=germany

  • Posted by Anonymous

    “the International Monetary Fund may sell some of its $64.7 billion in gold reserves”

    From the same rule book as HM Treasury’s?
    Guess who’s going to snatch those?
    What are 60 odd billion army in front of 4 trillion armada?

    Strikes me as someone willing to smooth reserves diversification into gold.

  • Posted by Guest

    The exchange markets are telling the world something very simple, let US made good flow. For too long nations across Europe and Asia have used technicalities to limit the flow of US made goods. For example, Buicks are hot item in China but it trade barriers limit the export of the product to China. Unacceptable!!! We have Europe blocking US electronics for decades. Unacceptable!!! We have Korea limiting US made goods. Unacceptable!!!

    I would urge more attention to the trade barriers unemployed by Europe and Asia.

  • Posted by bsetser

    Anonymous — I link to your measure of the euro’s real value would be appreciated. My sense is that the euro right now is extremely strong vis a vis asian currencies … and I would bet most indexes understate Asia’s weight in europe’s trade (It depends on how quickly the index is updated). The euro indexes will also give lots of wieght to the euro/ swiss franc/ nordics, since the eurozone trades a lot with all of them. But in some sense, now that most european currencies trade together, what interests me is the value of the euro relative to the other big parts of the world economy. Right now the euro is fairly strong v. $ and extremely strong v. Asia (given Asian productivity has increased enormously since the early 90s) and quite strong v. most EMs that manage their currencies primarily against the dollar.

    But I take your point that the german export machine is doing quite well right now with the euro at its current levels … (Italy, not so much …) and surging capital goods spending in many emerging economies bodes well for further growth. And I also do need to look more closely at the euro’s real index – its composition and so on.

    one last thing — are the values you mention nominal or real? Me thinks that eurozone inflation has been consistently lower than US inflation, which makes comparing nominal indexes over time a bit dicey. The dollar needs to depreciate slowly to stay constant in real terms v. the euro as US inflation has exceeded eurozone inflation.

  • Posted by HZ

    Brad,
    John Mauldin’s recent newsletter (quoting decisionpoint.com) has a Euro chart that shows the Euro equivalent at 1996 is above $1.30.
    Doesn’t higher US inflation (and USD depreciation) mean the current Euro level is less strong in real term than it appears to be?

  • Posted by Gheorghius

    I was lucky enough in December 2004, just as the Euro was rising above 1.34 against the dollar, to call for the end of the dollar slide, and warn my clients to liquidate their dollar shorts. (the Euro to 135.20, then fell back to 120).

    Since the beginning of 2005 I challenged Brad’s predictions of an immediate dollar slide, insisting that interest rates differentials and other fundamentals were enough (barely) to keep the dollar almost steady against the Euro (and appreciating against the Yen). Until this summer, I kept insisting, while the Yen kept depreciating. I was lucky again.

    But since September I started to argue that the dollar slide was coming. In October and beginning of November I forecasted that the dollar (against the Euro and the Yen) would break through its trading ranges “in November and December” 2006. I forecasted a sudden increase in volatility.I was lucky again.

    I also wrote that the move would be about 10-12%, and I explained that this was all what is needed to “jump” on the new equilibrium path, assuming a soft landing scenario in the US – barely avoiding a formal recession), although I warned that this was the most difficult and uncertain call, as currency mkts “tend to overshoot”.

    Now the point of this post is not how good I am – although I think RCG should hire me -: but rather that I think I proved my main point against Brad: that currency mkts were broadly rational and not massively misaligned (this summer I suggested a dollar undervaluation of 6% against the Jen). How I think I did prove my point? By explaining consistently the mkt behaviour in “rational” terms while correctly forecasting the moves and the pauses.

    On the other hand, Brad kept suggesting that the dollar was massively undervalued and that mkts were irrational. I don’t care so much who got it right,: we all know that a lucky monkey could be the best forecaster of us all (and I could be the lucky monkey this time). But when forecast and arguments go together and are repeatedly right, I think it becomes harder to ignore those arguments.

    The dollar won’t recover below 129.85 on Monday /Tuesday, however thin trading activity was on Friday; and the slide is likely to continue down to 140 at least. After having been called irrational for two years, I would be satisfied if the hypothesis of mkt (bounded & broad) rationality was accepted. Brad, take it! Fundamentals are not just about trade (& Cu.A.) deficits. Financial mkts have grown, but you seem not to realize it.

    Sometimes, it’s not reality that is irrational: its the glasses you wear.

  • Posted by bsetser

    Gheorghius — you clearly belong on a trading floor, not at RGE. But do note that my argument is that the $ is massively misaligned against a set of emerging market currencies (RMB/ GCC), not that it is massively misaligned v. the majors. I tend to think it will need to fall further v. the majors, but that is not central to my argument. What is central to my argument is that adjustment will eventually require a revaluation of the emerging markets that now peg to the $ …

    I did think the $ was massively overvalued v the majors in 01 — but at the time, I was at the TReasury/ IMF, not writing a blog.

    HZ — thanks for the Mauldin reference. Picking 1995 as your starting point tho is a bit suspect — that was the peak (may be a trough) of dollar weakness v. yen/ euro last time around. Look at the fed’s index v the majors.

    http://research.stlouisfed.org/fred2/series/TWEXM?&cid=15

    Based on the Mauldin charts tho it does seem as tho the $ is close to being at a nominal low v. the euro (it was around 1.31-1.32 in Asia last I checked). But you are right on the inflation point — with more inflation in the US than in europe, 1.30 now isn’t 1.30 in 95 either … maybe 1.40 is the equivalent to 1.30 then.

    One final point tho. back in 95, Germany was in the midst of its post-reunification boom, and European interest rates were quite high, supporting the now eurozone currencies. that isn’t so much the case now.

  • Posted by Guest

    “Ifo spokesperson Nerb noted that… German exporters could probably live with $1.30, but if it went beyond that to around $1.35, this would hurt quite a few exporters… “I think the higher euro will hurt the Spanish, French and Italian exporters more”… 4cast.com, Nov. 24/06

  • Posted by Dave Chiang

    Milton Friedman’s Cruel Legacy – “unrelenting, unapologetic self-interest”
    by William Greider
    http://www.thenation.com/issue/ (Dec 11, 2006 issue)

    Friedman’s broader argument–that a society should be governed by
    self-regulating markets instead of big government–did better but also
    did not lead to the utopia he promoted. His “free market” faith has
    produced instead the very thing Friedman regularly denounced: a
    bastardized system of interest-group politics that serves favored
    sectors of citizens at the expense of many others. Enterprise and
    markets were indeed set “free” of government regulation, but big
    government did not go away (it grew bigger). Only now government acts
    mainly as patron and protector for the largest, most powerful
    interests–the same ones that demanded their liberation. Instead of
    serving the broad general welfare, government enables capital and
    corporations to feed off the taxpayers’ money and convert public assets
    into private profit centers, shielded from the wrath of any citizens
    trying to object. If that is what Friedman really had in mind, he
    should have said so.

  • Posted by Guest

    Just looking at tonight’s headlines, also wondering if we should be paying more attention to tax issues, presuming the following could have meaningful implications for currency valuations:

    “…Germany, which takes over the EU presidency in January, is one of the main backers of the project – which aims to create a common basis for taxing corporate profits… However, some countries, including Britain and Ireland, are expected to opt out of the new system on the grounds that it impinges on national tax sovereignty…” http://www.ft.com/cms/s/ada83b6e-7d8c-11db-9fa2-0000779e2340.html

    “…Nineteen top British companies have moved parts of their operations overseas in the past two years… Three-quarters of those surveyed by the employers’ body said the corporate tax system had changed for the worse over the past five years and a quarter said it was significantly worse…” http://www.ft.com/cms/s/e60d278c-7d8f-11db-9fa2-0000779e2340.html

  • Posted by Guest

    And still not entirely clear as to why Hong Kong doesn’t get a bit more attention:

    “…The Hong Kong government, which has adopted the slogan “Asia’s world city” to emphasize its legal system and financial markets compared with China’s, bristles at the suggestion of dropping the peg…” http://www.bloomberg.com/apps/news?pid=20601109&sid=aopBk7jfctI0&refer=exclusive

  • Posted by bsetser

    How do tax issues explain the euro’s recent move?

    Hk is interesting. but presumably the lower than US itnerest rates reflect lots of funds that are parked in HK $ post Chinese bank IPOs/ others holding HK$ as part of a China play … not anything more. I am not one who thinks that HK is gonna shift its peg when the RMB trades through it. the HK $ needs to depreciate against the RMB much as the US $ does.

  • Posted by a

    “1.40 v euro = big. Over 50% move (I think) since early 02, record low, out of historic norms, etc.”

    Nah, 1.40 isn’t big. It’s 17% from the initial value of the euro, which the Europeans (at the time) thought would be a floor for the euro. A fall in the dollar to 1.40 over the next year presumably has odds significantly better than 50%.

    Now 1.75 is big.

  • Posted by Guest

    re:(at the time)

    “Statistical regress fallacy. Believing that the probability of future events is predictable by examining occurrences of past events…” http://en.wikipedia.org/wiki/Nassim_Taleb

    re: tax – Thinking more about affects on the Euro’s – and other key currencies’ moves going forward, especially if evolving market conditions force adjustments. Any changes may reveal more about the significance and specifics of current affects.

    The HK peg article is interesting (to me) as it is, in part, about how some of these factors add up to influence the ‘brand value’ component in a currency – that influences the sentiment trade.

  • Posted by Guest

    Brad–The dollar is likely to depreciate against the yen and the euro. The dollar-yen rate has declined to 115 yen recently, and will continue to do so toward 105 yen. The Japanese authrities appear to refrain from intervening the dollar-yen rate at least until it reaches 105 yen. The euro-dollar rate will eventually reach 1.40 dollar.

    All will of course depend on the economic conditions and monetary policies in G3. My assumption is that the US economy will slow down to 1.5-2%, and the Fed will start to reduce the FF rate early next year; the rueo zone will maintain 2-2.5% growth, and the ECB will continue to raise the interest rate; and the Japanese economy will also grow by 2-2.5%, but the BOJ cannot raise the interest rate because deflation would resist to disappear.