How Far Has the Dollar Climbed? And Why?
Kurt Brouwer November 10th, 2008
The dollar is gaining and the Euro is slowly sinking. What’s going on?
Source: Wikipedia Commons
The dollar has been strong for the past few months after going through years of decline versus the Euro. For more on the long decline, see How Far Has the Dollar Fallen? And Why? — What’s Next?. Now, of course, the dollar has turned around a bit and that strength has baffled many observers as well as normal folks. What’s going on?
To start, let’s put things in perspective with two charts from the treasure trove of information at the St. Louis Federal Reserve’s web site. The first chart shows the Euro (priced in dollars) since its inception in 1999. The low point was in 2001 when it costs 84 cents to buy one Euro. The high point came earlier this year when it cost nearly $1.60 to buy one Euro. In this chart format, the line going up indicates a time when the Euro is strengthening. When the line heads downward, it means the Euro is weakening versus the dollar:
Source: St. Louis Federal Reserve
In the next chart, we see the same information, but over a much shorter time period from July 4th through last week:
Source: St. Louis Federal Reserve
As this second chart makes clear, the dollar has been strong — and the Euro weak — since June. There has been a modest rally in the Euro which coincided with the Federal Reserve’s decision to drop the Fed Funds Target Rate. Normally, lower U.S. rates would be very bullish for the Euro, but the European Central Bank is also dropping rates these days, so the effect has been modest.
OK, so we’ve established the fact that dollar has strengthened considerably versus the Euro (and most major currencies), but we have not gotten to the point of why this is happening. Here’s my take:
First, the dollar was oversold and a rebound was bound to happen. This was pretty clear much earlier in the year. But, being oversold is more of a short-term phenomenon whereas I think this strength in the dollar is a long-term event. The second reason is that the dollar represents stability in troubled times.
This represents a remarkable turnaround for the dollar, which was was not receiving much love as recently as June. Now, that has changed in dramatic fashion as this Bloomberg piece [emphasis added] indicates:
Dollar Gains Most Since 1992 On Concern Global Slump Deepening (Bloomberg, October 25, 2008, Ye Xie)
The dollar gained the most in 16 years against the currencies of six major U.S. trading partners as a global economic slowdown spurred demand for the greenback as a haven from losses in emerging markets.
“The foreign-exchange market is basically saying we are in a global recession and perhaps a very, very deep one,” Richard Franulovich, a senior currency strategist at Westpac Banking Corp. in New York, said in an interview on Bloomberg Radio. “Any sense of rationality and fundamentals is thrown out the window.”
Japan’s yen also benefited as investors fled high-risk assets and used the proceeds to pay back low-cost loans taken out in the currency. The yen climbed to a 13-year high against the dollar this week and surged to its strongest level against the euro in six years. The pound fell below $1.53 in its biggest weekly drop since investor George Soros drove sterling out of Europe’s system of linked exchange rates in 1992.
The dollar appreciated 6 percent to $1.2623 per euro this week, from $1.3410 on Oct. 17. The currency touched $1.2497 per euro yesterday, the strongest since October 2006. The yen rallied 7.8 percent to 94.32 per dollar from 101.69, and touched 90.93 yesterday, its highest level since August 1995. Against the euro, the yen climbed 12.7 percent to 118.96 from 136.21. It touched 113.81 yesterday, the strongest since May 2002.
This week’s decline in the euro was its biggest against the dollar and the yen since the 15-nation currency’s inception in January 1999. The yen’s gain versus the dollar was the biggest since October 1998.
…”We are in a financial crisis,” said Richard Clarida, a global strategist at Newport Beach, California-based Pacific Investment Management Co., which oversees $830 billion in assets, including the world’s biggest bond fund. “The flight to quality is boosting the dollar and the yen.”
Emerging-market currencies tumbled as Argentina seized private pension funds, and Belarus, Ukraine, Hungary and Iceland joined Pakistan in requesting at least $20 billion of emergency loans from the International Monetary Fund. Brazil’s real dropped 8.2 percent to 2.3075 against the dollar, the South African rand decreased 10.4 percent to 11.18 and the Russian ruble fell 3.2 percent to 27.1991…
The final reason for the strength in the dollar is implicit in the quotes from the Bloomberg piece shown above even though the piece does not spell it out. With the dollar declining from 2001 through mid-year 2008, investments that were priced in currencies such as the Euro gained ground as the dollar fell. So, many U.S. investors who held international stocks and bonds or commodities gained from the dollar’s weakness. Those gains attracted lots of investment from U.S. investors which required that they sell dollars and buy other currencies.
In fact, a number of large pension plans and other institutional investors made significantly enhanced commitments to foreign holdings in the past few years and that put more selling pressure on the dollar. There was even talk of the Euro becoming the world’s reserve currency. All of that selling pressure coincided with the peak in the Euro and the low point for the dollar. Once savvy investors began seeing the potential for a turnaround (see Gross Likes Dollar vs. Euro For First Time), buying pressure on the dollar began increasing and the rout of the Euro was on.
I don’t want to make too much of this currency movement because it reflects lots of short-term uncertainty and volatility and when things ease up a bit, we may see a move back in the other direction. Yet, it still must be noted that when things get dicey, the world flocks to the U.S. dollar.
Why? Safety. Liquidity. The rule of law. Despite a Congress that acts like a bunch of spoiled children, investors want the dollar because they believe their money is safer here. Maybe Americans should take some comfort in knowing this.
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How much demand for dollars have we created ourselves by selling $800 billion in treasuries over the last two months? Purchasers of those treasuries have to find dollars to buy them with. This would seem to drive up the dollar.
Michael–good point. Obviously, it depends on who bought Treasuries and why they bought them. In the long run, it doesn’t matter what foreign investors buy (Treasuries or other U.S. investments). Any non-U.S. investor would have to convert his or her currency into dollar in order to purchase U.S. investments. We have seen foreign demand for real estate in Miami going up. Same with NYC real estate. And, no doubt the 40% off sale in U.S. stocks is attracting foreign buyers. Also, U.S. investors who are dumping foreign stock or bond funds and bringing those assets back home would stimulate demand for the dollar.
Or the U.S. dollar grew stronger because the credit markets around the world dried up. People had loans coming due and could not get the banks to extend their credit. The banks simply stopped lending. So the loads had to be paid off and the only way to do that is for the lendee to sell gold which is quite liquid and this drove the price of the gold down (temporarily). The would also sell other valuables like their vacation homes, their second car, jewelry to pay off the loans. If the loans were drawn on a U.S. bank, then the currency would have to be converted into U.S. $, there by increasing the demand for U.S.$. This was the short squeeze that drove the U.S.$ higher. But this is only temporary. With the U.S. spending another trillion dollars on the bailout, and billions more to bailout the automotive companies, the U.S. dollar will fall. The U.S. government is also selling 2 year treasury bills instead of 30 year bonds, and these bills will come due quite soon. The only way the government can pay for these redemptions is to print more money. The U.S. is in debt to the tune of $2 trillion dollars to foreign countries and it is unlikely they will buy up another $2.25 trillion in U.S. debt, especially since their financial institutions need bailing out too. China in December had declared they are no longer buying U.S. debt and it is doubtful that other foreign countries will continue to lend the U.S. money. The only solution is to default on the loans, or print trillions of dollars. I’m afraid it will be the latter. The U.S. doesn’t have the money to pay off the interest on their debt, so printing money is their only way out. This of course will devalue the currency quite rapidly causing gold and other commodities to sky rocket. The U.S. is out of money, up to their eye-balls in debt, and spending like there is no tomorrow. They are broke, and $10 trillion dollars in debt. The only direction the U.S. dollar is going to go in 2009 is DOWN!
Brent
MK…
I would have to disagree ,but Long Term Investments for the Future is definately a good read……