O'Neill sees good things for the dollar while investors bang the drum for euro
'When we get ready to change dollar policy I'm going to rent Yankee Stadium and get a marching band so you all will know we are changing,' said US Treasury Secretary Paul O'Neill earlier this year.
Can you hear the tuba and the big bass drum in the distance? The dollar can.
There's a flaw in O'Neill's analysis of the currency market. The dollar hasn't been strong because his predecessor Robert Rubin ordained that it should be. It's been strong because investors and traders made it so by buying the US currency and assets denominated in it. So it follows that a lower dollar isn't in O'Neill's gift, even if he wanted a weaker currency.
But it is in the power of investors and traders, and they've decided to drive the US currency to its lowest level against the euro in five months to express their concern about the outlook for the US economy.
Investors are banging the drum for the euro. Merrill Lynch's monthly fund manager survey showed 57% of those polled favoured the euro over the dollar, up from 40% in July. About 31% said they preferred the dollar, down from 43%. Merrill's questioned 268 fund managers responsible for about $282bn of assets.
(Luckily for the euro, it's 'quiet time' at the European Central Bank. With the guardians of monetary policy for the 12 nations that share the common currency away at the beach, there's less risk of a wayward comment knocking the euro from its current perch around 92 cents.)
O'Neill has painted himself into a corner on the subject of the dollar. 'One of the things I've learned in this job is there is no upside in talking about the dollar except to say we have a continuing and a continuous policy,' he told CNBC yesterday. So it doesn't matter if the dollar is worth 90 cents per euro, or 85, or 100; the US administration isn't going to share its view with the world for fear the currency would plunge.
That gagging order doesn't apply to the International Monetary Fund, which helped knock the legs out from under the dollar earlier this week by saying the currency may be in for a 'sharp depreciation' because of an unsustainable US current account deficit of 4.5% of gross domestic product. Which is kind of like hiring Yankee Stadium on O'Neill's behalf. The IMF's message isn't a new one; it delivered a similar warning in late June, saying the US' need for foreign financing would drive down the value of the currency. But the timing of the message is important; with the US economy showing no evidence of a rebound, investors would dearly love some clue that the US would prefer a weaker dollar ' and they're not going to get any such pointers from O'Neill.
'Saying he believes in a strong dollar is not information, it's not news, it's not even a view, it's irrelevant,' said Nick Parsons, global head of currency research at Commerzbank. 'But if you were a conspiracy theorist, you would love the idea that the US planted the story in the IMF report.'
So investors are dumping dollars because an off-the-leash O'Neill would probably welcome such a move to bail out US exporters, and because if it turns out that there's a 'V' in the US economy's future it's more likely to be vagrancy than Viagra.
The currency market, however, is a zero-sum game. To sell something ' in this case the dollar ' you have to buy something else. Your choices are yen or euros, and the Japanese economy is in a horrible condition, while the Bundesbank said that economic growth ground to a halt in Germany in the second quarter. If Europe's biggest economy isn't growing, it's tough for the region to turn in much of a performance. So all three of the world's major currencies are, arguably, in equally bad shape. That's still bad news for the dollar.
Parsons at Commerzbank estimates that Asian central banks have about 80% of their $1 trillion of foreign exchange reserves denominated in dollars. If they trimmed that to 60%, the central banks would have to sell about $200bn of the US currency and they'd 'still be overweight dollars,' Parsons said.
So you don't have to love the euro to anticipate the European currency holding or even extending its gains. 'This is the start of something bigger,' Parsons said. 'I don't think there's a great stock of euros in portfolios globally which will be liquidated. There is a stock of dollar investments held overseas, which is a function of the current account numbers, which is at risk of being liquidated.'
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