Tuesday, September 30, 2003

Currency & Marshall Auerback

Auerback as lucid as ever:

John Snow Lights the Fuse

“Be careful what you wish for” is an aphorism on which US Treasury Secretary John Snow might care to reflect in light of the foreign exchange market’s latest trashing of the dollar. Consider last weekend’s G7 communiqué from Dubai:

"We reaffirm that exchange rates should reflect economic fundamentals. We continue to monitor exchange markets closely and cooperate as appropriate. In this context, we emphasize that more flexibility in exchange rates is desirable for major countries or economic areas to promote smooth and widespread adjustments in the international financial system, based on market mechanisms."

The statement may well help to placate US domestic manufacturers (what’s left of them), who have been complaining loudly about competition from China, but such rhetoric from the G7 does not come without a cost.

Despite subsequent British denials that the statement reflected a change in policy, the G7 ministers have with this language attacked not only the Chinese currency peg but also the Japanese strategy of flooding the market with yen to forestall its appreciation. That policy has been critical to jacking up the Nikkei and generating a more accommodative global set of financial conditions because Bank of Japan Governor Fukui, in marked contrast to his predecessor, has left such sales of the yen unsterilised.

That is, until just a week ago, when the Yen cracked the important 115 to the dollar barrier, a sign, posits PIMCO’s CIO, Bill Gross, that the Asian appetite for dollars and U.S. Treasuries might be sated, and that the long enamored and widely held “Yen carry trade” might be on its last legs.

If true, it means a very important source of financing for the US external imbalances may be drying up, which is something the US can ill afford at this juncture. In the words of Paul Donovan, an international economist at UBS, “The precarious funding situation means the US administration needs to be delicate with any rhetoric on the currency or it risks accelerating what should ideally be a gradual fall in the dollar. If Asian support for the dollar or the Treasury market is no longer forthcoming, they would have a serious economic problem.” A serious economic problem which would have ramifications in Asia as well, notably Japan and China. ...{article link continued}

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