The Future of the Dollar - Newsweek: International Editions - MSNBC.com
The Future of the Dollar - Newsweek: International Editions - MSNBC.com
MSNBC.com
The Future of the Dollar
Jumping up is not likelynot with that debt burden.
By Stephen Glain
Newsweek International
Dec. 26, 2005 - Jan 2, 2006 issue - The smart money is betting, once again, that the days of the almighty dollar are numbered. And just because this prediction was startlingly wrong for 2005 doesn't mean it's wrong again for 2006.
After a yearlong bull run fed by rising U.S. interest rates, political disarray in the euro zone and sustained dollar buying by Asian central banks, the dollar is running out of fuel, say economists and investors. The latest warning shot came when the European Central Bank, led by president Jean-Claude Trichet, earlier this month raised its basic interest rate for the first time in 30 months, a move that could attract investors to the euro. After the first quarter of 2006 "things get dicier" for the dollar, says Anton Pil, global head of fixed income for JP Morgan Private Bank. "You'll start seeing the unwinding of dollar positions back into euros and yen... and then the debt cloud will re-enter the picture."
Over the last year, the dollar rose about 15 percent against the euro and yen. That defied virtually all forecasters, who thought America's growing debts would chase investors away from the dollar, and occurred despite a continuing run of news that, in theory, should have depressed the currency: the troubles in Iraq, record-high oil prices and hurricanes on the Gulf Coast.
How could that happen? Even as America's trade deficit continued to swell, hitting a record $66 billion in September, concern about its potentially harmful effects was muted by generally strong and inflation-free economic growth. Meanwhile, the Fed was gradually making the dollar more attractive by raising rates in quarter-point steps, or a total of 1.75 percentage points over the year, to 4 percent. This steadied the nerves of investors who "carry" dollars and dollar-based assets in short- to midterm trades for the higher returns they offer, compared with what's available in slow-growth Europe and Japan. In a move not widely noted outside financial circles, the Bush administration also dramatically cut taxes on profits remitted to the United States, from 35 percent to 5.5 percent. That added further stimulus to the dollar at a time when political chaos in Europe, from race riots in Paris and France's rejection of the EU constitution to the inconclusive outcome of elections in Germany, was undermining the euro.
Asian central banks, which sell their own currencies for dollars to enhance their export competitiveness and account for more than half of the world's $2.5 trillion in foreign reserves, continued to be loyal dollar buyers. The fright that rattled exchange markets in February, when South Korea's central bank implied it was switching out of dollar-based assets, proved ephemeral. "It seemed market forces should have put downward pressure on the dollar," says Jared Bernstein, an economist at the Economic Policy Institute, "but that hasn't happened because Asian governments in general and China in particular are so heavily invested in that product."
American manufacturers who compete with Asian exporters say such a store of dollars amounts to currency manipulation, and have agitated for the White House to take action. They were disappointed last month when the U.S. Treasury Department refused to cite Asia's second largest dollar buyer, China, for any misdeeds. Lawmakers howled in protest, and threatened to unveil a bill that would slap punitive tariffs on Chinese-made imports. But they look unlikely to get such a bill past the White House.
Absent stiff pressure from Washington, say industrialists and lawmakers, China will continue to buy enough dollars to keep the dollar on its current upward slope. That's absent any countervailing force, however, and economists say they expect one in the form of higher interest rates within the next six months or so. Higher rates would draw traders to non-dollar-based investments, such as European and Japanese equities and bonds. The consensus seems to be for a slight shift in direction: JP Morgan's Pil anticipates one euro will be worth $1.20 by mid-2006, up from $1.17 today, while a dollar will buy only 115 yen, down from 120.
If the unexpected rise of the dollar in 2005 helped dampen concern about America's budget and trade deficits, even a slow slide could revive the debate. Growing pressure on Congressthe National Association of Manufacturers says the dollar must weaken at least an additional 12 percentcombined with rising energy prices, Gulf Coast rebuilding costs and the growing toll of the Iraq war could tip the balance in favor of dollar hawks. The irony is that if the hawks successfully pressure China to revalue, that would reduce Chinese demand for dollars, perhaps precipitating a sudden collapse in the U.S. currency, which no one wants. "We're always thinking in the back of our mind, 'Could the dollar crash?' " says Bernstein. "That's the nightmarethat China stops buying our assets. But it's hard to imagine a steep selloff, barring unforeseen circumstances." Let's hope the consensus forecasters are right this time.
© 2005 Newsweek, Inc.
© 2005 MSNBC.com
URL: http://www.msnbc.msn.com/id/10513234/site/newsweek/
MSNBC.com
The Future of the Dollar
Jumping up is not likelynot with that debt burden.
By Stephen Glain
Newsweek International
Dec. 26, 2005 - Jan 2, 2006 issue - The smart money is betting, once again, that the days of the almighty dollar are numbered. And just because this prediction was startlingly wrong for 2005 doesn't mean it's wrong again for 2006.
After a yearlong bull run fed by rising U.S. interest rates, political disarray in the euro zone and sustained dollar buying by Asian central banks, the dollar is running out of fuel, say economists and investors. The latest warning shot came when the European Central Bank, led by president Jean-Claude Trichet, earlier this month raised its basic interest rate for the first time in 30 months, a move that could attract investors to the euro. After the first quarter of 2006 "things get dicier" for the dollar, says Anton Pil, global head of fixed income for JP Morgan Private Bank. "You'll start seeing the unwinding of dollar positions back into euros and yen... and then the debt cloud will re-enter the picture."
Over the last year, the dollar rose about 15 percent against the euro and yen. That defied virtually all forecasters, who thought America's growing debts would chase investors away from the dollar, and occurred despite a continuing run of news that, in theory, should have depressed the currency: the troubles in Iraq, record-high oil prices and hurricanes on the Gulf Coast.
How could that happen? Even as America's trade deficit continued to swell, hitting a record $66 billion in September, concern about its potentially harmful effects was muted by generally strong and inflation-free economic growth. Meanwhile, the Fed was gradually making the dollar more attractive by raising rates in quarter-point steps, or a total of 1.75 percentage points over the year, to 4 percent. This steadied the nerves of investors who "carry" dollars and dollar-based assets in short- to midterm trades for the higher returns they offer, compared with what's available in slow-growth Europe and Japan. In a move not widely noted outside financial circles, the Bush administration also dramatically cut taxes on profits remitted to the United States, from 35 percent to 5.5 percent. That added further stimulus to the dollar at a time when political chaos in Europe, from race riots in Paris and France's rejection of the EU constitution to the inconclusive outcome of elections in Germany, was undermining the euro.
Asian central banks, which sell their own currencies for dollars to enhance their export competitiveness and account for more than half of the world's $2.5 trillion in foreign reserves, continued to be loyal dollar buyers. The fright that rattled exchange markets in February, when South Korea's central bank implied it was switching out of dollar-based assets, proved ephemeral. "It seemed market forces should have put downward pressure on the dollar," says Jared Bernstein, an economist at the Economic Policy Institute, "but that hasn't happened because Asian governments in general and China in particular are so heavily invested in that product."
American manufacturers who compete with Asian exporters say such a store of dollars amounts to currency manipulation, and have agitated for the White House to take action. They were disappointed last month when the U.S. Treasury Department refused to cite Asia's second largest dollar buyer, China, for any misdeeds. Lawmakers howled in protest, and threatened to unveil a bill that would slap punitive tariffs on Chinese-made imports. But they look unlikely to get such a bill past the White House.
Absent stiff pressure from Washington, say industrialists and lawmakers, China will continue to buy enough dollars to keep the dollar on its current upward slope. That's absent any countervailing force, however, and economists say they expect one in the form of higher interest rates within the next six months or so. Higher rates would draw traders to non-dollar-based investments, such as European and Japanese equities and bonds. The consensus seems to be for a slight shift in direction: JP Morgan's Pil anticipates one euro will be worth $1.20 by mid-2006, up from $1.17 today, while a dollar will buy only 115 yen, down from 120.
If the unexpected rise of the dollar in 2005 helped dampen concern about America's budget and trade deficits, even a slow slide could revive the debate. Growing pressure on Congressthe National Association of Manufacturers says the dollar must weaken at least an additional 12 percentcombined with rising energy prices, Gulf Coast rebuilding costs and the growing toll of the Iraq war could tip the balance in favor of dollar hawks. The irony is that if the hawks successfully pressure China to revalue, that would reduce Chinese demand for dollars, perhaps precipitating a sudden collapse in the U.S. currency, which no one wants. "We're always thinking in the back of our mind, 'Could the dollar crash?' " says Bernstein. "That's the nightmarethat China stops buying our assets. But it's hard to imagine a steep selloff, barring unforeseen circumstances." Let's hope the consensus forecasters are right this time.
© 2005 Newsweek, Inc.
© 2005 MSNBC.com
URL: http://www.msnbc.msn.com/id/10513234/site/newsweek/
posted by Eastlaw at Tuesday, December 27, 2005
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