# What is behind the U.S. dollar's fall?



## stockGURU (6 November 2004)

Good jobs numbers out in the U.S. today but the dollar continues to fall against all major currencies. It has been stuck in a serious downtrend for over three years.

So, what are the major factors that are driving the U.S. dollar down and where do you think it find a bottom?

Any thoughts?

 :nuts:


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## markrmau (6 November 2004)

http://www.nytimes.com/aponline/business/AP-Euro-Rally.html

It's an interesting topic. Basically the US twin deficits, Chirac's concern and Schroderes statement that the European union shouldn't do anything about it.

I just hope that the US dollar depreciation is orderly and doesn't become a crisis. (It will kill my nws shares and hurt Aussie exports). 

However gold prices suggest the US has a long way to fall.

Cheers, Mark.


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## stefan (8 November 2004)

There is much more behind the fall of the dollar than the deficit and the election. I for one believe that we are in for a bit of a shock. 

A few years ago Warren Buffett started betting that the dollar would fall significantly. Until recently, so called experts here and abroad have pointed out how wrong he was while he just kept going. Why did he do that?

- He's a very clever man
- He doesn't care what others do
- He's able to add 1 + 1 without getting confused 

Well, all of the above are true but look closely for yourself and you find that you don't have to be a wiz to see that it was unavoidable:

The reason can be found in Asia. For years, Asian banks have continued to buy US dollars to keep their own currency low. And while their economy has built so much steam that it's now about to explode, the US went nowhere. There is a massive force building in China, Japan and India and it will make the US economy look like a jar of pocket money in the coming years.

From the economist website:

After slipping 14% in broad trade-weighted terms since 2002, the dollar had stabilised this year, even as the current-account deficit continued to grow. This has encouraged some economists to offer theories explaining why America's current-account deficit does not matter and why the dollar need not fall further. But the dollar has now started to slide again.

The dollar's latest slide seems to have been triggered by uncertainty about the presidential election and a flurry of comments from Fed officials. Robert McTeer, the president of the Dallas Federal Reserve, mused (only “theoretically” of course) that when capital inflows into America dry up, “there will be a crisis that will result in rapidly rising interest rates and a rapidly depreciating dollar that will be very disruptive”. 

Policymakers' usual reply when asked about exchange rates is to say that they are set by the market. But if the dollar was truly being set by the market it would now be much weaker. The dollar has fallen by over 30% against the euro since 2001, but its trade-weighted index has fallen by much less because of heavy intervention by Asian central banks, aimed at holding down their currencies against the dollar. This policy seems likely to continue, despite China's decision this week to raise interest rates for the first time in nine years. That decision was aimed at curbing its overheating domestic economy, rather than bolstering its currency.

Because Asian currencies have been held down against the dollar, America's current-account deficit has continued to swell, reaching almost 6% of GDP in the second quarter. The dollar is already below most estimates of its fair value against the euro, but it will need to undershoot if the deficit is to be reduced. Economists at UBS estimate that the dollar's trade-weighted value might need to fall by another 20-30% to trim the deficit by enough to stabilise the ratio of America's external liabilities to GDP. Though it might seem unthinkable, that could imply a rate of around $1.70 against the euro. 

Other economists, however, argue that America can sustain its large current-account deficit for at least another decade, without a sharp fall in the dollar, because it will be happily financed by China and other Asian countries. In a series of papers Michael Dooley, David Folkerts-Landau and Peter Garber at Deutsche Bank have argued that the present arrangements resemble a revived Bretton Woods, the system of fixed exchange rates after the second world war. 

Asian economies, they argue, have chosen to link their currencies to the dollar at undervalued rates, supported by heavy purchases of dollar reserves. Asian countries want to keep their exports cheap to support rapid growth and are in consequence happy to keep acquiring dollars indefinitely. In turn, by buying Treasury bonds, they reduce interest rates, which supports spending and ensures that American consumers keep buying Asian goods.

Since 2001, Asia's official reserves have increased by $1.2 trillion, equivalent to two-thirds of America's cumulative deficit over that period. Currency intervention by Asian central banks helps to explain why America has so far been able to finance its deficit without higher American bond yields or a bigger fall in the dollar. However, the claim that the deficit is sustainable for another decade is highly dubious. 

An excellent paper by George Magnus, an economist at UBS, argues that the parallels with Bretton Woods are superficial. One big difference is that in the 1960s the United States ran a current-account surplus and was a net creditor to the rest of the world. Today, America is the world's biggest debtor, which could undermine the dollar's role as an anchor currency. 

Second, it is wrong to describe the Asian countries as habitual “peggers”. In the 25 years to 1998, non-Japanese Asian currencies typically fell against the dollar, and over the same period their countries mainly ran current-account deficits, not surpluses. Their more-firmly-tied exchange rates and current-account surpluses generally date only from 1998 when these countries needed to rebuild reserves after the Asian crisis. Their desire to tie their currencies to the dollar may be a temporary response to a cyclical problem. 

A third important difference is that, unlike under the Bretton Woods regime, most Asian countries have scrapped capital controls or where they still exist, as in China, they are leaky. This requires much greater “sterilisation” by central banks to prevent an increase in reserves spilling into faster credit growth. As sterilisation has become less effective, excessive credit growth is pushing up inflation and causing overinvestment in property, especially in China. As the inflationary costs of maintaining their link to the dollar grow, Asian countries may shift to more flexible regimes. 

Lastly, under Bretton Woods there was no real alternative to the dollar as a reserve currency. Today there is the euro, into which Asians could diversify.

Mr Magnus reckons that the revived Bretton Woods is an illusion which will crack within a year or two. Even if it lasts longer, it is a dangerous way to run the world, for it encourages both China and America to pursue reckless policies. Excessive liquidity is causing the Chinese economy to overheat. Meanwhile, by buying Treasury bonds, Asian central banks are subsidising American borrowing costs, encouraging more consumer profligacy, and so allowing the current-account deficit to get even bigger. The inevitable correction will then be all the more painful.

Until recently, some argued that America's current-account deficit was sustainable because foreign investors were eager to buy American assets to take advantage of the economy's faster productivity growth and hence its higher returns. But private inward investment has slumped, leaving America dependent on foreign central banks. And foreign savings are no longer financing investment and hence future productivity gains as they were in the late 1990s. Foreigners are now financing consumption and government borrowing. 

America's current-account deficit largely reflects puny domestic saving, so dollar bulls often argue that a fall in the dollar is neither necessary nor sufficient to trim the deficit. But Stephen Roach, chief economist at Morgan Stanley, reckons that a weaker dollar would spark a rise in real bond yields, as foreign creditors demanded extra compensation for currency risk. That would slow consumer spending, boost saving and reduce the deficit. 

In the three years from 1985, the dollar fell by 50% against the other main currencies. Inflation and bond yields rose and, in October 1987, the stockmarket crashed. America's current-account deficit is now almost twice as big as it was then, so the total fall in the dollar””and the fall-out in other financial markets””could well be larger.

- End of article. -


Happy trading

Stefan


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## Mofra (9 November 2004)

Stefan,

That is a fantastic post, thank you, very interesting.
Another feather in the cap for the argument to prepare a defensive portfolio or at least a plan to deal with the end of the bull run? Seems to me like another signal to increase gold exposure.

Cheers


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## RichKid (9 November 2004)

That's right Gold is the way to go in uncertain times- especially if you find a stock with good div yield.


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## stefan (21 November 2004)

Finally the old man in the US is saying what he should have said a long time ago. Instead of just painting a bright picture of the US economy and its future, he's now taking a slightly different view... IMHO this could well be the first "official" sign that the falling US dollar will indeed lead us into a rather bumpy ride:

- Start of article -

While in Frankfurt, Germany yesterday, US Federal Reserve (Fed) Chairman Alan Greenspan warned that the US foreign trade deficit could negatively effect the country's economy. Greenspan also noted the devaluation of the dollar, and that it too could adversely affect the economy.

Though the growing US deficit has not presented a problem so far, there could be some future risks, especially if the imbalance of payments remain on current trade accounts. While recognizing that loans from foreign investors have so far financed the US current deficit, Greenspan admitted that if foreign investors suddenly gave up investing in the dollar, problems might arise. In such a case, he continued, charging off of foreign investors' their shares and US debentures in the US companies, their prices will drastically fall while interest rates will climb. Greenspan concluded: "If looked at the size of the current US deficit, the desire for dollars would decrease at some point; however, when, and through which channels and to what level will the dollar drop? Unfortunately, there is no credible answer to these questions." 

Meanwhile, German Minister of Finance Hans Eichel indicated that the devaluation of dollar would not benefit the US. Ankara Chamber of Industry (ASO) Chairman Zafer Caglayan said that a decrease in the dollar will probably continue.

- End of article -

Have a nice weekend 


Stefan


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## markrmau (21 November 2004)

I have suspected for a while that the US administration would like a lower dollar, so that the american consumer stops financing world growth and concentrates on US growth. Greenspan's comments confirm this. Think of how fantastically the low AUD worked for Australia over the last 4-5 years. 

I'll step out on a limb here and say that I think there will be one last big drop in USD when china revalues the yuan, then it will bottom out. 

PS. I have no economics training so this may be rubbish. Cheers, Mark.


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## wayneL (25 November 2004)

Found this article...interesting:

Stephen Roach, the chief economist at investment banking giant Morgan Stanley, has a public reputation for being bearish.

But you should hear what he's saying in private.

Roach met select groups of fund managers downtown last week, including a group at Fidelity.

His prediction: America has no better than a 10 percent chance of avoiding economic ''armageddon.''

Press were not allowed into the meetings. But the Herald has obtained a copy of Roach's presentation. A stunned source who was at one meeting said, ''it struck me how extreme he was - much more, it seemed to me, than in public.''

Roach sees a 30 percent chance of a slump soon and a 60 percent chance that ''we'll muddle through for a while and delay the eventual armageddon.''

The chance we'll get through OK: one in 10. Maybe.

In a nutshell, Roach's argument is that America's record trade deficit means the dollar will keep falling. To keep foreigners buying T-bills and prevent a resulting rise in inflation, Federal Reserve Chairman Alan Greenspan will be forced to raise interest rates further and faster than he wants.

The result: U.S. consumers, who are in debt up to their eyeballs, will get pounded.

Less a case of ''Armageddon,'' maybe, than of a ''Perfect Storm.''

Roach marshalled alarming facts to support his argument.

To finance its current account deficit with the rest of the world, he said, America has to import $2.6 billion in cash. Every working day.

That is an amazing 80 percent of the entire world's net savings.

Sustainable? Hardly.

Meanwhile, he notes that household debt is at record levels.

Twenty years ago the total debt of U.S. households was equal to half the size of the economy.

Today the figure is 85 percent.

Nearly half of new mortgage borrowing is at flexible interest rates, leaving borrowers much more vulnerable to rate hikes.

Americans are already spending a record share of disposable income paying their interest bills. And interest rates haven't even risen much yet.

You don't have to ask a Wall Street economist to know this, of course. Watch people wielding their credit cards this Christmas.

Roach's analysis isn't entirely new. But recent events give it extra force.

The dollar is hitting fresh lows against currencies from the yen to the euro.

Its parachute failed to open over the weekend, when a meeting of the world's top finance ministers produced no promise of concerted intervention.

It has farther to fall, especially against Asian currencies, analysts agree.

The Fed chairman was drawn to warn on the dollar, and interest rates, on Friday.

Roach could not be reached for comment yesterday. A source who heard the presentation concluded that a ''spectacular wave of bankruptcies'' is possible.

Smart people downtown agree with much of the analysis. It is undeniable that America is living in a ''debt bubble'' of record proportions.

But they argue there may be an alternative scenario to Roach's. Greenspan might instead deliberately allow the dollar to slump and inflation to rise, whittling away at the value of today's consumer debts in real terms.

Inflation of 7 percent a year halves ''real'' values in a decade.

It may be the only way out of the trap.

Higher interest rates, or higher inflation: Either way, the biggest losers will be long-term lenders at fixed interest rates.

You wouldn't want to hold 30-year Treasuries, which today yield just 4.83 percent


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## markrmau (25 November 2004)

As I said before, I am just a mug punter and really know bugger all about the subject, but perhaps this should be considered:

1. Talk of the US twin deficits is not new news. This has been discussed at least since the begining of the year. Alan Kholer had a big segment on the ABC a few months ago.

2. Remember how concerned the bears were about the US deficit in the 90's? They had the deficit bus running around with the trillion dollar figures written on the side. However, the US out-grew this problem.

3. It is not the US that is asking asian governments to buy the US dollar and bring about the bigest "vendor finance scheme ever" as someone put it. As the US dollar sinks, they are screwed more than the US. It is even beneficial to the US.

Just an alternative viewpoint, I think the US economy will pull out of this.

Cheers,Mark.


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## stefan (26 November 2004)

> 3. It is not the US that is asking asian governments to buy the US dollar and bring about the bigest "vendor finance scheme ever" as someone put it. As the US dollar sinks, they are screwed more than the US. It is even beneficial to the US.



IMHO that's where you're wrong. 
Asian countries have been buying the dollar because they wanted to keep their own currency low so that they can stimulate their own economy. That has now happened. China is growing quicker than they would like, Japan is taking the turn, India is about to show its real power and the US is left with a falling currency, higher interest rates and an economy which is going nowhere. We have yet to realise that the US economy is nothing more than some pocket money compared to what is about to hit us from Asia. They had enough time to prepare themselves. Now that their ready, the US is realising that something went wrong and that it wasn't an act of goodwill from Asia to support their deficit by buying the dollar. Now that the dollar is falling, Asia will stop buying it. Who's left after that? Russia has just announced that they will change part of their policy to the Euro instead of the Dollar. Show me one party that would be interested in buying US dollars. Just one will do... 

The US was more than happy that Asian Governments were buying the dollar as this was the only way to finance their deficit. Yes, they were looking to increase their export chances and a lower dollar was regarded as beneficial. But now the fall has picked up momentum and Greenspan is already getting nervous. You see, a falling dollar will ultimately lead to higher interest rates in the US. There is NO way to prevent this from happening. Now higher interest rates means bad news for the average house owner with no savings (No wonder Howard won the election based on this scary thought). If Greenspan has to lift rates quicker than the market is willing to accept then the stockmarket is in for a fall. 

It's all looking rather gloomy I'm affraid. Just to say that the US will find a way out of this can only be put under "ignorance is bliss". The only hope is that the events will unfold modestly rather than in a wave of panic. Currently the world is still willing to believe that the US economy is growing, but we haven't seen much evidence lately. The problem is time. I am not so sure there's enough of it left for the US to avoid serious trouble. 

No need to panic, but keep it in mind. Just because the ASX is running hot doesn't mean it's all paradise out there. We should take the chance to build up some savings during the good times. Now's the time!

Happy trading

Stefan


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## markrmau (27 November 2004)

Well lets look at Greenspan's comments. Obviously he knew what the effect of his words would be. He has always been very careful and deliberate with what he says. So it follows that he wants the US dollar to be sold of against the Euro. Perhaps as an extra little nudge to get China to revalue the Yuan.

I think this also goes with the Russian comments. If you were going to sell USD and buy Euro, only a fool would say the things the Russians did. Perhaps if they had already readjusted their portfolio and were looking at coming back the other way would they say that.

US interest rates: I don't think it is a given that they will be increased at anything other than a measured pace from their current 'accomodating level' to 'neutral'. I think the US will do what Australia did in the late 90's and say that the exchange markets can take care of themselves (of course our economy is completely different from US). Again for Australia it was a disaster to continually raise interest rates to prop up the dollar at the turn of 80's/90's culminating in a recession that was worse than it needed to be. Also, we didn't have run away inflation at the end of the 90's when our dollar was worth bugger all, and our pricing is far more relient on imports than the US (we produce little finished products locally). In short, I don't see the case for US interest rates to rise at a rate above  what they have already indicated.

Also, have a look at this chart. 

http://finance.yahoo.com/q/bc?t=3m&s=USDEUR=X&l=on&z=m&q=b&c=&c=^DJI

At worst, the US stock market is unconcerned by the USD fall, possibly the market may be encouraged by it (or possibly they are not correlated at the moment).

I'm not suggesting people go long the USD just yet. As I said, I think it has a bit more to fall after China revalues the Yuan (though maybe I am wrong here). However, I think it is almost at the bottom, and the sky isn't falling in.

Cheers,
Mark.


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## stefan (27 November 2004)

> I'm not suggesting people go long the USD just yet. As I said, I think it has a bit more to fall after China revalues the Yuan (though maybe I am wrong here). However, I think it is almost at the bottom, and the sky isn't falling in.



I don't think it's anywhere near a bottom, yet. All the arguments you listed are certainly true but they don't look at the current situation. They are based on history and how things were in the 90s. It is quite a different story today and I don't think we've seen something like that ever before. Interesting article in the Times regarding the Dollar:

http://www.nytimes.com/2004/11/27/business/27dollar.html

It pretty much sums up what I mentioned before. There will be panic once China stops buying Dollars. Anyway, we will see what happens and if it can all be done in a controlled, moderate way.

Interesting times ahead. How high will the Aussie Dollar go?

Have a nice weekend

Stefan


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## markrmau (5 December 2004)

http://www.nytimes.com/2004/12/05/business/yourmoney/05doll.html?oref=login

Another interesting article - more towards Stefan's argument of increasing interest rates etc.


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