Defending The Dollar
Kurt Brouwer March 20th, 2008
Source: Wikipedia
For our latest thinking on the dollar, click here:
How Far Has the Dollar Fallen? And Why? — What’s Next?
In the last day or two, we have seen some signs of life in the slumping dollar. The dollar has perked up slightly and most commodity prices have fallen — some a little bit and some (such as gold) a lot.
The dollar tends to respond most quickly to changes in the Fed Funds rate. As that interest rate falls or rises, the dollar usually moves in the same direction. However, it does not always work that way. The Fed again cut rates yesterday, but it appears that the currency markets see an end to the cutting because the dollar strengthened.
Though the weakness in the dollar has been good for U.S. exports (see Trade Deficit Down — Economic Growth Up), it has been bad for imports, particularly commodities. Now, some observers think the U.S. Treasury needs to take action to get the greenback going up again [emphasis added]:
Time For Some Treasury Dollar-Defense (Kudlow’s Money Politic$, March 20, 2008, Larry Kudlow)
With the dollar rising all of a sudden, and commodity prices plunging, this would be a great time for the Treasury to get out there and buy dollars. Totally squeeze the short sellers. Right now. Send a clear statement that the U.S. wants a stronger dollar. It would do a lot to reduce inflation expectations. And it would drive gold prices down $200 from here.
…The Fed helped the dollar and hurt commodities by its “less is more” policy decision Tuesday, where they cut the fed funds rate by 75 basis points instead of 100. They also devoted more attention to the inflation threat in their policy statement. Meanwhile, two Reserve Bank presidents — Dick Fisher in Dallas and Charlie Plosser in Philadelphia — dissented from the 75 basis point cut due to their concerns over inflation.
The Fed is coming to the end of the easing road. They are laying the groundwork for a sounder greenback. Now’s the time for the Treasury to come in and punctuate the change in Fed policy and commodity- and currency-market sentiment…
It is my belief that the dollar will not move up significantly against the Euro or the yen until the interest rate differential is reduced (see How Far Has the Dollar Fallen? And Why?). As the Fed is cutting rates here, the only way for the interest rate differential to be reduced would be for the central bank in Europe to do a reduction in rates. That is possible, but not likely right now. So, the dollar is not likely to rebound strongly until the interest rate environment changes.
If the dollar is not likely to strengthen on its own in the near term, what then? What Kudlow is referring to is intervention in the currency markets by the U.S. Treasury such that it would buy dollars. If the Treasury did that in a big way, it would send a frisson of fear the through world of currency speculators who have been betting against the dollar (see Will Central Banks Stop the Dollar’s Slide?).
Interventions such as this have a mixed history, but if they are done from a position of strength — as the recent rebound in the dollar might attest — then they can be successful.
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