Monday July 20, 2009 - 19:06:04 GMT
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May the dollar has traded in a limited four figure range against the euro -
limited and a bit odd. Good American economic news pushes the dollar down; bad
news returns it to favor.
May Non Farm Payrolls, unexpectedly positive,
gave the dollar a fainting spell. The June numbers, worse than predicted,
revived the greenback. Retail sales figures and consumer confidence have
gradually returned from oblivion and the value of the dollar ebbed as they
Risk aversion is the standard explanation. Risk capital, or
perhaps it is better to name it capital that is averse to risk, is sequestered
in Treasury bills and other dollar denominated safe investments when the
economic environment looks, well, risky. The demand for these dollar assets
pushes the US currency higher as foreign denominated capital enters the currency
markets and is converted to dollars. When economic risk is judged to diminish
these funds suddenly pour back out of US Treasuries seeking higher returns.
Since those returns are often overseas the dollars are changed for foreign
assets and the dollar sinks.
This mechanistic and simplified logic may
suffice to explain the weak pro and anti-dollar moves that have played back and
forth in the currency since late May. But a larger question looms. Why hasnâ€™t
the dollar benefited from the improvement in the US economy? Currency markets,
like equities and futures, are discounting machines. They trade now for where
their participants think that currencies, stocks or commodities will be at some
point in the near future.
The US economic situation compares favorably
with that of any of its major currency trading partners. The financial panic has
long since dissipated. The banking system is not going to collapse. Present
inflation is benign, whatever the real or imagined fears for 2011 and beyond.
The Federal Reserve has restrained its essay into overt monetization. At the
last FOMC meeting the Reserve Board declined to add to the $300 billion already
allotted for Treasury purchases.
most informative indicator of current Fed thinking is the long
neglected M2 money supply. Last
fall and spring as the crisis escalated the
amount of currency in circulation had jumped at historically
unprecedented rates as the Fed pumped liquidity into the economy. But now it
seems the Fed has drawn back from the money glut, the increase in M2 has halted and that can
only help to contain future inflation.
One year ago the US unemployment
rate was 5.5 %, it is now 9.5%. While such numbers are a serious hardship for
workers and businesses they are also a sign of the flexibility of the US labor
market. Because American firms operate under relatively few restrictions they
are free to use labor as they see fit. US firms can restructure and redeploy
resources to meet actual demand. When growth returns US firms are often in a
better financial condition to rehire. US unemployment rises faster in a
recession but it also falls faster and to a lower level under economic growth.
Compare the US employment situation to that of the European Monetary Union
EMU unemployment has risen from 7.4% a year ago to 9.5% in June,
half the amount of the US increase. In Europe it is far harder for firms to
eliminate workers and doing so is far more costly. Thus when the recovery begins
there are fewer empty places to fill. Companies remain wedded to resource
deployment designed for the last expansion with no guarantee that the new cycle
will ask for the same product mix. In comparison US firms are able to meet the
new economic situation with a far more flexible outlook.
US economic indicators have improved substantially in the past months. Housing
is stable, purchasing managers indices have recovered and consumer confidence
and retail sales are on the mend. This is not to say that the recession is
ended or even ending. But that as a comparative lesson the US is arguably in
better shape for recovery than its European competitors. When this improved
economic situation is joined to the historical ability of the US economy to work
its way out of trouble faster and with more emphasis than any other
industrialized economy we have to ask again: Why has the dollar
The answer may lie in Washington and the political and economic
agenda of the Obama administration. Currency markets are making their own
discount judgments on the potential economic effect of the two major initiatives
of the administration: the climate change bill and the creation of a government
Irrespective of the political and policy aims of the
two pieces of legislation and aside from any opinion on the social and
environmental desirability of their stated goals, there is no doubt that both
will impose huge economic costs on the US economy. For the climate bill the
intention is to apply a proper cost to carbon output. The legislation is
designed to impose huge new taxes on any users of carbon. Since almost every
consumer or industrial product uses carbon somewhere in the production cycle the
economic costs will stretch across the entire economy.
service bill cannot be funded without raising taxes and will likely incur large
additional deficit spending as well. Few economists advise raising taxes in a
recession. A further increase in the already vast Federal deficit could well
squeeze out much of credit needed for the private economy and raise the cost of
credit for all. Both bills, if passed in present form, seem destined to restrict
US economic growth and retard recovery from the recession.
equities have had a strong recent surge as the passage of these bills has become
more problematic. The currency markets will soon notice. If the climate bill
fails and the universal health care provision is watered down or put off until
next year then restraints on the dollar will fall away and it could follow equities higher.
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