Saturday, April 12, 2008

The beginning of the end of the dollar rout....or the end of the beginning?

Well, well, well.

The G7 appeared to signal some concern over the decline and fall of the dollar empire yesterday, changing the boilerplate language in their communique:

"We reaffirm our shared interest in a strong and stable international financial system. Since our last meeting, there have been at times sharp fluctuations in major currencies, and we are concerned about their possible implications for economic and financial stability. We continue to monitor exchange markets closely, and cooperate as appropriate. We welcome China's decision to increase the flexibility of its currency, but in view of its rising current account surplus and domestic inflation, we encourage accelerated appreciation of its effective exchange rate."

The new text, shown in bold, can only refer to the dollar. So is this it for the dollar rout? Macro Man has long thought that the endgame for the current dollar downtrend will be a commitment from the relevant authorities to act to turn it around. However, it's far from clear that the G7 are the relevant authorities; after all, it's not Japan or Germany or the UK that is buying billions of EUR/USD every month; it's China and Russia and the Middle Eastern Countries. And Macro Man didn't see their names attached to any document expressing concern.

Moreover, it's worth taking a look back at history to gauge how significant this statement is. In the context of the last 25 years, the language is pretty limp. Compare the above, for example, with the language from the September 2000 communique expressing concern over the weakness of the euro:

"We discussed developments in our exchange and financial markets. We have a shared interest in a strong and stable international monetary system. At the initiative of the European Central Bank, the monetary authorities of the United States, Japan, United Kingdom and Canada joined with the European Central Bank on Friday, September 22, in concerted intervention in exchange markets, because of the shared concern of Finance Ministers and Governors about the potential implications of recent movements in the euro for the world economy. In light of recent developments, we will continue to monitor developments closely and to cooperate in exchange markets as appropriate."

Of course, at that point, the authorities had already intervened in foreign exchange markets. And even then, it was a full 18 months before the euro finally put in a clear bottom against the dollar.

How about the last time that there was a legitimate will amongst the authorities to prop up the dollar, in 1995?

" The ministers and governors expressed concerns about recent developments in exchange markets. They agreed that recent movements have gone beyond the levels justified by underlying economic conditions in the major countries. They also agreed that orderly reversal of those movements is desirable, would provide a better basis for a continued expansion of international trade and investment, and would contribute to our common objectives of sustained noninflationary growth. They further agreed to strengthen their efforts in reducing internal and external imbalances and to continue to cooperate closely in exchange markets."

Observe how 13 years ago, the G7 essentially stated that exchange rates were misvalued and should reverse. That's a much stronger statement than the observation that there have been "sharp fluctuations"; indeed, the latter phrase seems to say more about volatility than direction.

And how about the Grandaddy of them all, the Plaza Accord? Those were the days when men were men (unless they were Maggie Thatcher), and G7 (or G5) statements were bold and forthright:

"The Ministers and Governors agreed that exchange rates should play a role in adjusting external imbalances. In order to do this, exchange rates should better reflect fundamental economic conditions than has been the case. They believe that agreed policy actions must be implemented and reinforced to improve the fundamentals further, and that in view of the present and prospective changes in fundamentals, some further orderly appreciation of the main non-dollar currencies against the dollar is desirable. They stand ready to cooperate more closely to encourage this when to do so would be helpful."

Again, observe the direct language expressing a clear directional bias that is absent from yesterday's communique. The language of the Louvre Accord, essentially "taking profit" on the Plaza, is similarly forthright.

Ultimately, when the history books are written, yesterday's communique may be seen as a small first step to end the dollar's decline. But small is what it is, regardless of whether the dollar stages a handsome rally on Monday. Absent a commitment by the Europeans to cut rates to lessen the euro's lustre (a reticence that recalls the Bundesbank's reluctance after the Louvre Accord, which ultimately helped spark the '87 stock market crash) and, importantly, Voldemort and co. to quit selling dollars in the open market against other free-floating currencies, it's hard to see any dollar rebound enduring, especially given the weakened state of the US economy and financial markets.

The beginning of the end? Nah. But it just might be the end of the beginning.

Old G7 statements can be found at the University of Toronto's excellent G8 resource center, linked to the right.)


Anonymous said...

Yes, exactly which money is going to be used to intervene? I think they have somewhat more pressing business in keeping the banks from collapsing. I am unable to conjure up a plausible means by which they could intervene without causing much more serious problems in the financial system.

--Charles of MercuryRising

FX said...

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CV said...

@ FX ...

You have definitely come to the right place.

On the G7 ... I think that this once again shows that talk is cheap in this context. We will see of course come tomorrow what happens but I don't think that it is safe to short the EUR/USD yet (although I don't want to long either :)). Trichet made this pretty clear last Thursday I think. Poor Italy and Spain is what I say ... at this point they should be pretty weary of the fact that Germany continues to run along. As for next week in a more concrete sense I guess the USD will have a resurgence on the back of the G7 but I have my eyes fixed on the ZEW sentiment index for Germany thus gauging whether Q2 potentially may be where Germany re-couples back to reality and the ongoing correction in Eastern Europe. Remember that it was one of these ZEW readings that participated in cracking the 1.50 barrier in the first place.


CV said...

Oh wait ... I think was a bit too quick there. Was it not an IFO (i.e. industrial confidence) survey that cracked the 1.50 barrier for the EUR/USD?

Anonymous said...

i wonder how much of the lower volumes that we are seeing in the equity markets is due to declining participation by quant funds. does anyone have any information regarding that?

Lord said...

The thought occurred to me that a falling dollar is not a blanket positive for large US firms. Many like Alcoa are actually in the import business and will be harmed while others are in exports or in translating earnings from abroad and will be helped.