By Brendan Murray
Oct. 13 (Bloomberg) -- President Barack Obama’s effort to lead the world economic recovery by spending the U.S. out of its recession is undermining the dollar, triggering record commodities rallies as investors scour the globe for hard assets.
As threats of a financial meltdown fade, the currency is falling victim to an unprecedented budget deficit, near-zero interest rates and slow growth. The dollar is down 10 percent against six trading partners’ legal tender in Treasury Secretary Timothy Geithner’s first eight-and-a-half months, the sharpest drop for a new occupant of that office since the Reagan administration’s James Baker persuaded world leaders to boost the deutsche mark and yen by debasing the dollar in 1985. This year’s drop followed its best two quarters in 16 years.
“The dollar had been strong because the U.S. was a haven in the storm, and now that the storm is abating, who needs the dollar?” said Edmund Phelps, who won the 2006 Nobel Prize in economics and teaches at Columbia University in New York. “People got exasperated with the tiny returns on safe assets.”
Investors are sating their renewed risk appetites with developing nations’ stocks, currencies and the commodities some of them produce. Gold is up 19 percent this year, touching an all-time high $1,062.70 an ounce on Oct. 8. Copper has rallied 103 percent with the biggest three-quarter rise in at least 21 years. Crude oil, up 64 percent, just finished its steepest eight-month climb since 1999. Aluminum has gained 24 percent, propelled by its best two quarters in a dozen years or more.
Worst Since 1991
The MSCI Emerging Markets Index yesterday reached 950.34, the highest since August 2008, after the 22-year-old gauge’s biggest seven-month rally. The Dollar Index, which measures the currency against the euro, yen, pound, Canadian dollar, Swedish krona and Swiss franc, dropped to its lowest level since August 2008 on Oct. 8 after its worst two quarters since 1991.
The nonpartisan Congressional Budget Office estimates that the budget deficit for the fiscal year that ended Sept. 30, which included some of Obama’s $787 billion stimulus package and the lowest tax revenue in more than 50 years, was $1.4 trillion, more than India’s gross domestic product. The administration will announce the final figure by mid-October.
Faced with administration projections of shortfalls totaling $9.1 trillion over the next decade, Obama and Congress have pledged to restore discipline. Fed officials have discussed how -- but not when -- they plan to reduce the central bank’s balance sheet, which has doubled to $2.1 trillion under emergency lending programs to unfreeze the credit markets.
‘Lofty Assurances’
“The most important thing coming from investors in Asia, where I am, is despite all these lofty assurances by U.S. officials that there’s a credible exit strategy from both fiscal and monetary stimulus, they understandably don’t believe it,” said Stephen Roach, chairman of Morgan Stanley Asia in Hong Kong.
Geithner, 48, has adopted the past two administrations’ policy of publicly favoring a “strong dollar.” It fell 24 percent in George W. Bush’s first four-year term, which ended Jan. 20, 2005, and rose 1.3 percent in his second.
“We are going to do everything necessary to make sure we sustain confidence” in the U.S. economy, Geithner said Oct. 3 in Istanbul.
Lawrence Summers, director of the White House’s National Economic Council, echoed Geithner’s statement in an Oct. 8 interview. “He made it very clear that our commitment is to a strong dollar based on strong fundamentals,” Summers said.
U.S. Interventions
Those words may ring hollow without direct government action to support the dollar or more evidence that the fiscal and monetary stimulus will be short lived. The U.S. hasn’t moved to shore up its currency by purchasing dollars since 1995. It intervened to weaken the dollar against the yen in 1998 and to support the euro in 2000.
“Currencies that have the lack of support of petroleum, metals, and have a liberal central bank posture toward printing money are currencies that will continue to be punished,” said Peter Kenny, managing director in institutional sales at Knight Equity Markets in Jersey City, New Jersey. “The U.S. dollar is a classic example of that.”
Commodities “insist on validation and validity,” while currencies “are subject to politics and perception,” he said.
HSBC Holdings Plc economists Stephen King and Stuart Green said in a report this month that the end of U.S. economic supremacy is at hand.
Their report predicted the “demise of the West” amid “ongoing struggles in the developed world” and said that “emerging market nations are set to dominate world economic activity in the years ahead.” Titled “The Tipping Point,” the report said currencies will be weak in countries “still pondering exit strategies and faced with multiple years of debt repayment.”
Growth Prospects
“The most obvious candidates are the U.S. dollar and sterling,” they wrote. Emerging-market economies will expand 6 percent next year, more than three times the 1.8 percent growth in developed economies, they said.
China’s 9.5 percent economic growth and India’s 7.2 percent increase will lead all nations next year, the HSBC economists predicted. In contrast, GDP will expand 2.8 percent in the U.S., 1.2 percent in Japan and 0.7 percent in the 16-nation euro zone, they said.
“Asia is taking its place again on the world stage” and the wealth shift is occurring “more rapidly than anyone would have thought,” said Stephen Green, HSBC group chairman, in an Oct. 6 interview in Istanbul.
As the dollar slips, silver and gold have outperformed all major currencies since the Sept. 15, 2008, announcement of Lehman Brothers Holdings Inc.’s collapse as investors favored the metals over legal tender.
‘Sniff of Inflation’
“Gold serves as a hedge against inflation, and even though we are in the midst of a recession worldwide, the sniff of inflation is already in the air,” said Richard O’Brien, chief executive officer of Newmont Mining Corp., the largest U.S. gold producer, on Oct. 2.
The dollar is suffering even as American stocks rebound from a 13-year low reached in March. One reason: the 19 percent increase in the Standard & Poor’s 500 Index this year is trailing gains in stocks in most other nations.
Of 82 countries’ benchmark stock indexes tracked by Bloomberg, 60 performed better this year than the S&P 500 as of yesterday. Peruvian stocks lead the world with a 120 percent gain. The U.S. edged out gains by Bangladesh, New Zealand and Finland. Ghana, down 41 percent, is in last place.
Even measured against the March 9 start of the S&P 500’s biggest rally since the 1930s, the U.S. index’s 59 percent gain puts it in 39th place worldwide.
Highest Unemployment
With excess production capacity in the U.S. near an all- time high and unemployment at 9.8 percent, the highest in the Group of Seven, restoring the world’s largest economy to the 3 percent growth rate of the past two expansions may take years.
“The U.S. recovery is not yet clearly under way and other parts of the world, particularly emerging markets and commodity- based countries, are ahead of us,” said Michael Mussa, a senior fellow at the Peterson Institute in Washington and the International Monetary Fund’s former chief economist.
Niall Ferguson, a Harvard University professor, said that “it would be extraordinary” if the dollar didn’t weaken in the next year.
Obama administration officials are likely to tolerate a decline unless it “gets to an extent where it’s causing trouble,” Jim O’Neill, chief economist at Goldman Sachs Group Inc., said in an interview in Istanbul.
Excessive Drop
In an e-mail response to questions from Bloomberg News on Oct. 9, O’Neill said he considers the dollar’s recent drop excessive and predicted the currency will be stronger in a year, especially against the yen.
The dollar slumped to a postwar low of 80.63 yen in April 1995, only to rally 26 percent in the following two years. The Dollar Index reached a 10-year low in December 2004 on concern the U.S. current-account deficit was unsustainable, then rebounded 13 percent in 2006.
“We’re in the midst of a classic overshoot of the dollar,” said Michael Rosenberg, former head of foreign- exchange research at Deutsche Bank AG and a Bloomberg consultant. He said the U.S. outlook next year is more favorable than Japan and the euro area, the country’s current-account deficit is narrowing and the bond market isn’t reflecting inflation fears.
Rosenberg cited the 16 percent rise this year in the Reuters/Jefferies CRB Index of 19 commodities as evidence that the flight to raw materials isn’t widespread. Natural gas is down 49 percent and wheat has lost 31 percent.
Shorting the Dollar
The dollar is succumbing to momentum in a market that’s “lost its anchor,” Rosenberg said. “From 2001 to 2009, the best strategy was to close your eyes and short the dollar.”
The rebalancing of global wealth away from the U.S. as reflected in the dollar is likely to take years if not decades, said Carmen Reinhart, a University of Maryland economist who co- wrote a 2009 book with former IMF chief economist Kenneth Rogoff on the history of financial crises.
After World War II, the U.K. currency’s downfall was predicted “long before the sterling crisis of 1967 put the final nail in the coffin of the British pound as a reserve currency,” Reinhart said.
The dollar’s share of reserves in countries that report currency allocations fell in the second quarter to the lowest level since the euro was introduced in 1999. Reinhart predicted the dollar will remain the world’s most widely used currency for years and that any slide will be gradual until a viable alternative comes along.
“The euro hasn’t been fulfilling that role. The yen? Forget it. And the yuan is not convertible,” Reinhart said of the European, Japanese and Chinese currencies. “This is not something that’s around the corner here.”
To contact the reporters on this story: Brendan Murray in Washington at brmurray@bloomberg.net;
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