Amber light flashing on U.S. dollar intervention
Wed Jul 16, 2008 4:04 PM ET
By Mike Dolan - Analysis
LONDON (Reuters) - Three days before the last bout of coordinated central bank intervention to calm world currency markets, the International Monetary Fund's top economist opined: "If not now, when?" Many experts are now asking the same.
In 2000, when Michael Mussa urged the world's big central banks to calm the markets, it was the euro's seemingly endless slide which was perceived to be destabilizing the world economy. Now, it is the plight of the U.S. dollar that is ringing alarm bells.
The greenback set record lows again on Tuesday in its alarming downward spiral as severe questions are being asked by overseas investors about the financial reliability of the world's biggest economy and its financial obligations.
Once lost, investor confidence can take years to restore.
The risk to the dollar in that environment is stark and given few governments around the world have any interest in seeing a further devaluation of the U.S. currency, support for concerted intervention is on the rise.
The dollar's decline has clearly exaggerated oil and food prices worldwide, complicating monetary policies from the United States to the euro zone and Britain as well as to the export-oriented economies of Asia and the Middle East.
As the world economy slows after a year of credit turmoil, dollar-exaggerated inflation has tied the hands of central banks everywhere from cutting interest rates, and dollar losses also squeeze the export-driven growth engines of emerging economies.
"The United States should consider intervening on the foreign exchanges," said Jim O'Neill, chief global economist at Goldman Sachs in London. "The dollar's ongoing weakness and aggravation of the oil price is a threat to the whole world."
"There's a danger of a vicious circle developing here -- the dollar is declining across the board, oil prices are still rising and both are causing simultaneous inflation damage."
"They can't just stand idly by and watch all this happen without a fight," O'Neill added.
Goldman Sachs are not alone in warning of the possibility of dollar-supportive intervention.
"The conditions for successful dollar supportive coordinated intervention are now starting to fall into place," economists at French bank BNP Paribas told clients on Wednesday, saying the most important factor was a growing global consensus.
U.S. investment firm Morgan Stanley said its in-house model on the probability of central intervention has been rising all year and reckons chances are now as high as one in three.
Investors as well as bankers feel the time is ripe.
"The return of coordinated intervention in the foreign exchange market could prove to be one surprise in the coming months," said Edouard Carmignac, President of Luxembourg-based fund manger Carmignac Gestion told his clients on Tuesday.
PUSH COMES TO SHOVE
So how bad is it?
Against a euro bolstered by this month's European Central Bank interest rate rise, the dollar set a record of $1.6038 and its lowest in three months against a basket of world currencies <.DXY> -- within 1 percent of uncharted levels.
In testimony before a U.S. House of Representatives' panel on Wednesday, Federal Reserve Chairman Ben Bernanke treaded carefully around a question whether intervention was needed, but he pointedly noted it should not be set aside as a policy tool.
"I think it's something that should be done only rarely, but there may be conditions in which markets are disorderly where some temporary action may be justified," the U.S. Fed chief said.
Ultimately, the dollar's value "depends really on the fundamentals and it's up to us to get the fundamentals right," he added, in a tacit acknowledgment that the currency is becoming less attractive as U.S. economic woes mount.
The dollar index that weighs it against a basket of other currencies is down 10 percent in a year and has now dropped more than 40 percent in just over six years. Meanwhile, crude oil prices denominated in dollars have risen more than sevenfold over the same period.
What is more, the dollar and the euro are fast approaching the sort of moves that preceded some of the most famous coordinated central bank interventions in recent history.
In the five years leading up to the 1985 Plaza Accord that devalued the U.S. dollar, the greenback's trade-weighted index had risen about 50 percent. The euro's equivalent measure has done exactly that since it was rescued by the ECB and the other Group of Seven central banks in 2000.
The unease around the globe is palpable.
China, under fire for years to allow its semi-pegged yuan rise faster, has started to do just that over the past year. But it now faces growing domestic dissent about the damage that may wreak on exports.
That anxiety is mirrored across Asia and also in the petrodollar boomtowns of the Middle East, whose strict dollar pegs are also at breaking point despite recent reassurances from a visiting U.S. Treasury Secretary Henry Paulson.
But as a weakening economy, housing market slump and hobbled banks all infect each other stateside, the Federal Reserve's medicine of more than halving interest rates to 2 percent since last September looks to have worn off.
Dollar-linked inflation suggests rates should rise, but pervasive financial weakness now argues for even lower rates.
The dollar is taking the brunt of the policy stalemate.
Salt in the wounds has come from Treasury's need to bail out giant state-sponsored mortgage lenders Fannie Mae and Freddie Mac on Sunday, casting a pall over U.S. assets.
As the Fannie/Freddie crisis has snowballed this month, their borrowing premia over U.S. Treasuries has ballooned to near one full percentage point. But much more worryingly, the bailout has even raised doubts about what has for decades been seen as the safest of safe -- AAA-rated U.S. government debt.
Credit insurance costs on a U.S. Treasury default, although still small, surged this month to some 16-20 basis points and exceeded other major sovereigns by a significant measure for the first time ever. German premia for example, are 5 basis points.
On top of another 10 percent dollar fall over the past year, that will surely have unnerved overseas investors who hold more than $2.6 trillion of U.S. Treasury Securities. Two-thirds of this is held by foreign governments, which also own more than a $1 trillion in Fannie and Freddie debt.
By Mike Dolan - Analysis
LONDON (Reuters) - Three days before the last bout of coordinated central bank intervention to calm world currency markets, the International Monetary Fund's top economist opined: "If not now, when?" Many experts are now asking the same.
In 2000, when Michael Mussa urged the world's big central banks to calm the markets, it was the euro's seemingly endless slide which was perceived to be destabilizing the world economy. Now, it is the plight of the U.S. dollar that is ringing alarm bells.
The greenback set record lows again on Tuesday in its alarming downward spiral as severe questions are being asked by overseas investors about the financial reliability of the world's biggest economy and its financial obligations.
Once lost, investor confidence can take years to restore.
The risk to the dollar in that environment is stark and given few governments around the world have any interest in seeing a further devaluation of the U.S. currency, support for concerted intervention is on the rise.
The dollar's decline has clearly exaggerated oil and food prices worldwide, complicating monetary policies from the United States to the euro zone and Britain as well as to the export-oriented economies of Asia and the Middle East.
As the world economy slows after a year of credit turmoil, dollar-exaggerated inflation has tied the hands of central banks everywhere from cutting interest rates, and dollar losses also squeeze the export-driven growth engines of emerging economies.
"The United States should consider intervening on the foreign exchanges," said Jim O'Neill, chief global economist at Goldman Sachs in London. "The dollar's ongoing weakness and aggravation of the oil price is a threat to the whole world."
"There's a danger of a vicious circle developing here -- the dollar is declining across the board, oil prices are still rising and both are causing simultaneous inflation damage."
"They can't just stand idly by and watch all this happen without a fight," O'Neill added.
Goldman Sachs are not alone in warning of the possibility of dollar-supportive intervention.
"The conditions for successful dollar supportive coordinated intervention are now starting to fall into place," economists at French bank BNP Paribas told clients on Wednesday, saying the most important factor was a growing global consensus.
U.S. investment firm Morgan Stanley said its in-house model on the probability of central intervention has been rising all year and reckons chances are now as high as one in three.
Investors as well as bankers feel the time is ripe.
"The return of coordinated intervention in the foreign exchange market could prove to be one surprise in the coming months," said Edouard Carmignac, President of Luxembourg-based fund manger Carmignac Gestion told his clients on Tuesday.
PUSH COMES TO SHOVE
So how bad is it?
Against a euro bolstered by this month's European Central Bank interest rate rise, the dollar set a record of $1.6038 and its lowest in three months against a basket of world currencies <.DXY> -- within 1 percent of uncharted levels.
In testimony before a U.S. House of Representatives' panel on Wednesday, Federal Reserve Chairman Ben Bernanke treaded carefully around a question whether intervention was needed, but he pointedly noted it should not be set aside as a policy tool.
"I think it's something that should be done only rarely, but there may be conditions in which markets are disorderly where some temporary action may be justified," the U.S. Fed chief said.
Ultimately, the dollar's value "depends really on the fundamentals and it's up to us to get the fundamentals right," he added, in a tacit acknowledgment that the currency is becoming less attractive as U.S. economic woes mount.
The dollar index that weighs it against a basket of other currencies is down 10 percent in a year and has now dropped more than 40 percent in just over six years. Meanwhile, crude oil prices denominated in dollars have risen more than sevenfold over the same period.
What is more, the dollar and the euro are fast approaching the sort of moves that preceded some of the most famous coordinated central bank interventions in recent history.
In the five years leading up to the 1985 Plaza Accord that devalued the U.S. dollar, the greenback's trade-weighted index had risen about 50 percent. The euro's equivalent measure has done exactly that since it was rescued by the ECB and the other Group of Seven central banks in 2000.
The unease around the globe is palpable.
China, under fire for years to allow its semi-pegged yuan rise faster, has started to do just that over the past year. But it now faces growing domestic dissent about the damage that may wreak on exports.
That anxiety is mirrored across Asia and also in the petrodollar boomtowns of the Middle East, whose strict dollar pegs are also at breaking point despite recent reassurances from a visiting U.S. Treasury Secretary Henry Paulson.
But as a weakening economy, housing market slump and hobbled banks all infect each other stateside, the Federal Reserve's medicine of more than halving interest rates to 2 percent since last September looks to have worn off.
Dollar-linked inflation suggests rates should rise, but pervasive financial weakness now argues for even lower rates.
The dollar is taking the brunt of the policy stalemate.
Salt in the wounds has come from Treasury's need to bail out giant state-sponsored mortgage lenders Fannie Mae and Freddie Mac on Sunday, casting a pall over U.S. assets.
As the Fannie/Freddie crisis has snowballed this month, their borrowing premia over U.S. Treasuries has ballooned to near one full percentage point. But much more worryingly, the bailout has even raised doubts about what has for decades been seen as the safest of safe -- AAA-rated U.S. government debt.
Credit insurance costs on a U.S. Treasury default, although still small, surged this month to some 16-20 basis points and exceeded other major sovereigns by a significant measure for the first time ever. German premia for example, are 5 basis points.
On top of another 10 percent dollar fall over the past year, that will surely have unnerved overseas investors who hold more than $2.6 trillion of U.S. Treasury Securities. Two-thirds of this is held by foreign governments, which also own more than a $1 trillion in Fannie and Freddie debt.
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