Will Central Banks Stop the Dollar’s Slide?
Kurt Brouwer March 13th, 2008
In general terms, short-term interest rates seem to have the most impact on the dollar’s value versus the Euro or the British pound. For a much more detailed post on this issue, see How Far Has the Dollar Fallen? And Why?. And, recent events certainly back up this relationship as the dollar has fallen precipitously during this period of frequent cuts in the Fed funds rate.
Now, the problem is that the economy is slumping and the Federal Reserve likes to cut interest rates during slumps. But, if the dollar falls too far and too fast, that issue may preclude the Fed from making further interest rate cuts.
The first commentator I read calling for intervention on behalf of the dollar was Larry Kudlow in a post on his blog (see Resurrect King Dollar and Are Paulson and Bush On the Same Dollar Page?). Now, Morgan Stanley and Goldman Sachs are suggesting that just such an intervention may be needed [emphasis added]:
Dollar’s Slump Puts Morgan, Goldman On ‘Intervention Watch’ (Bloomberg, March 13, 2008, John Fraher & Simon Kennedy)
The dollar’s record-breaking slide may trigger the first coordinated effort to prop up the currency in 13 years, say strategists at Morgan Stanley and Goldman Sachs Group Inc.
The currency today fell below $1.56 per euro and slumped to the lowest level in 12 years versus the yen. That has prompted complaints from European Central Bank President Jean-Claude Trichet and Japanese Finance Minister Fukushiro Nukaga. U.S. Treasury Secretary Henry Paulson said today he backs a “strong dollar” and refused to elaborate when questioned at a press conference in Washington.
The challenge for policy makers is fighting the $3.2 trillion-a-day currency market while the Federal Reserve cuts interest rates and the U.S. economy falters. With traders increasing bets on a weaker dollar, the Group of Seven nations may be compelled to act, some strategists said.
“We’re on an intervention watch,” Stephen Jen, Morgan Stanley’s London-based head of foreign-exchange research, said in a telephone interview today. “While I don’t think we have reached the threshold yet, the argument in favor of it is gradually becoming compelling.”
The dollar today dipped below 100 yen for the first time since 1995, when the G-7 last stepped in to prop up the U.S. currency. It’s lost 15 percent against the euro since September as the Fed’s rate reductions dull the currency’s allure. The slide has accelerated in the past two weeks, putting the euro at $1.5624.
Executives and politicians across the world say they’re becoming increasingly worried about the dollar’s decline.
Of course, there are other benefits from the falling dollar at play too. In fact, the U.S. is benefiting from an export boom based in part of the declining dollar. And, the EU is worried — as always — about inflation, so it is not totally unhappy with the falling dollar either.
A united bid to aid the dollar may still not be around the corner. For now, a falling U.S. currency and surging euro are giving support to a weakening American economy by spurring its exports. It’s also helping the ECB contain inflation, which is at a 14-year high of 3.2 percent.
Supporting the dollar may also prove futile as its decline partly reflects the Fed’s cuts and the ECB’s decision not to follow, said Chris Turner at ING Financial Markets…”
At this point, it would appear that the handwringing about the dollar by various central bankers and other world leaders is just rhetoric. But, intervention is still a distinct possibility, particularly if the dollar continues falling.
Unfortunately, currency interventions by central banks are not always successful. A successful intervention would almost certainly require cooperation among the major industrialized central banks and it would have to be accompanied by a cessation of interest rate cuts by the Federal Reserve. It would also have to include a public relations campaign of central bankers proclaiming a commitment to strengthening the dollar.
- Economy , Geopolitics , Money
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Kurt, so far since June 2007, we’ve had events in the financial markets that make it seem as though we’re living the whole financial timeframe from the Great Depression, to ’70s shortages/stagflation, to Junk Bond debacles, to S&L Bailouts, to LTCM, to the dot.com bubble burst ALL IN THE SPACE OF ABOUT 9 MONTHS. Yet there’s probably a better than 50% chance this will all conclude by the end of the year with minimal recessionary damage (Yes, I’m expecting flatline-negative GDP growth this first half).
Is what we’re seeing here partially a consequence of the Information Age, in which problems occur and solutions in the financial/credit markets get implemented at neural speed. Could the “Feiler Faster” theory really be running amok here?
Brad–Your point is certainly correct in that events and information flow much more quickly these days. No doubt, the Internet has much to do with that. I did not think of this effect in terms of compressing decades of events into nine months though. I’ll have to give it some thought, but you may be on to something. Also, I imagine you’re a reader of Mickey Kaus. Isn’t the Feiler Faster Theory, his idea originally?
Kurt, from Wikipedia’s entry on Bruce Feiler:
He is credited with formulating the Feiler Faster Thesis: the increasing pace of society and journalists’ ability to report it is matched by the public’s desire for more information.
It mainly involves how journalism wraps its brain around the Information Age, but’s it’s self-evident that the rest of society is forming around this.