London Financial Times. Cross-currents make currencies choppy
Published: April 2 2005 03:00.
We live in a world of currency weaklings. The dollar has the giant US trade deficit. But other big currencies have their troubles too. While most experts predicted the dollar to fall this year, it rose against the euro and the yen in the first quarter. The culprit: economic weakness in Europe and Japan, which weighs on interest rates. These contrary forces ensure that currencies are not a one-way bet.
There is an important difference between them. Europe and Japan could solve their problems without a currency decline. Solving the US problem almost certainly requires the dollar to weaken further on a trade-weighted basis. But what is not 100 per cent certain is whether it needs to fall further against the euro and the yen to achieve this.
The euro does not have much to recommend it, other than not being the dollar. The eurozone economy remains sluggish. The European Central Bank is waiting for European politicians to reform their economies. Germany apart, little progress has been made. Meanwhile, the markets have had to consider the weakening of the growth and stability pact and the possibility of a No vote in the French referendum on the European constitution. While most investors considered the pact to be flawed and few give two figs for the EU constitution, the sense that the authorities are not in control is alarming.
Meanwhile, investors are still waiting for the Japanese economy to develop a self-sustaining recovery. Late last year, Japan again flirted with recession. While recent data have not all been bad (there was a rise in the purchasing managers' index this week), yesterday's Tankan survey shows sentiment to be weak.
In so far as economic growth drives currency movements, the dollar looks a better bet. With expansion firmly entrenched, the Federal Reserve is in tightening mode. US short rates are now three-quarters of a percentage point above eurozone rates while Japanese rates remain around zero. The gap is expected to widen.
The choppiness of the currency markets reflects investors being torn between three factors; the trade deficit (negative for the dollar) and growth and rate prospects (positive). In truth, there are good reasons for selling all three of the world's main currencies.
But could they all fall? Yes, against either gold or the Chinese renminbi. In recent years, gold has been a useful hedge against the dollar, but not against the euro or yen. Meanwhile, the US, Japan and the EU would all like to see the renmimbi revalue, but so far the Chinese are not playing.
Chinese exports create jobs, inflation remains moderate and Beijing has no desire to do anything that might expose the fragility of its banking system. Yet a token revaluation would do little to reduce the US deficit and would spur hot money inflows. The Chinese might echo the former US Treasury secretary who said: "It's our currency. But it's your problem."
