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Wednesday October 27, 2010 - 15:15:01 GMT
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Forex Blog - Geithner's Dollar Put (FXA)

Geithner's Dollar Put


To be perfectly clear I am working more off circumstantial evidence than anything I have learned from officials but I think there is strong evidence of an implied bargain made at G20 which falls way short of a “grand bargain” but should be seen as the Geithner dollar put…the US Treasury is ready to act decisively to support the dollar should the decline meet the following G20 criteria “Advanced economies, including those with reserve currencies, will be vigilant against excess volatility and disorderly movements in exchange rates.” 


What we do know about G20 is that the US came under significant pressure from most meeting participants over the role QE2 is playing in funneling global savings into emerging markets which are resisting appreciation via intervention and capital controls and thereby forcing the adjustment process onto developed country currencies like the yen and euro.  Though the likes of Europe, Japan, Britain and Canada are eager to see the emerging currencies of Asia appreciate especially China, Bernanke in particular was on the defensive in light of the very obvious policy decision by the Chairman and his supporters to embark on a new round of QE next Wednesday which pushed the developed G20 nations into the arms of the developing nations eager to bash the US. 


While Bernanke could never make QE2 conditional on the dollar, the US currency is not going to be ignored when setting monetary policy (perhaps why the Hilsenrath piece today came out…emphasis for those who failed to get it right in prior leaks to WSJ is on gradual or incrementalism initially…suspect this was for G20 critics and less for markets as nothing new in report – see my earlier email).  Bernanke is going to do what is best for US growth and inflation, not what harms Japanese exporters and Brazilian officials worried about a rising BRL and asset bubbles.  The US Treasury makes dollar policy and Geithner and company can assure the FX market no longer has an easy one-sided trade shorting the greenback.  This is what officials at the Fed and Treasury used to refer as instilling 2-way risk with FX intervention.  Keep in mind that the Fed sterilizes FX intervention as a rule and I would expect this to happen ahead if any USD are purchased by the Fed (and Treasury) as they split intervention operations down the middle) in light of its main policy thrust which is growing the money stock by purchasing assets (unsterilized). 


What other evidence is there of a Geithner USD put?  Well his comments on not devaluing the USD were rushed out for his California appearance last week before he left for Korea anticipating and hearing through its communications channels what many G20 officials were thinking…the US has swapped a strong dollar policy for a weak dollar policy.  Recall how odd it was for Trichet to be left alone to chant the US-strong-dollar-policy mantra (I suspect Trichet learned in Gyeongju that the US has retired the mantra…oops).  Geithner also rushed out his letter to G20 to turn a currency adjustment shouting match (Mantega war…he and Meirelles boycotted the meeting to underscore their unhappiness with US policy) into a current account adjustment discussion and agreement.  Unfortunately, few surplus countries were willing to bite apart from Japan…certainly not China and not Germany


So to save the meeting and achieve the ceasefire Geithner implied the US is ready to act to defend the dollar…verbally and physically…I believe.   He also told the WSJ that the US believes developed country currencies now reflect fundamentals (ie USD does not need to weaken more versus the yen and euro).  I doubt the US would have trouble finding other G20 states to join them in currency intervention ahead if Fed QE2 leads to disorderly or excessive FX moves.  But it is also very clear that the move down in the dollar against major currencies has been orderly to date…does not meet the criteria for more direct US (led) support for the greenback.    


Intervention is no panacea for arresting a decline in the dollar and it is not seen as one either by most officials at G20, with the Japanese the exception (surely given approval for more unilateral intervention at G20).  Moreover, with the ECB eager to end unconventional policy accommodation and normalize rates and EU governments embarking ever more aggressively on removing stimulus, one has to ask how low can EURUSD go with the Fed on incremental QE2 (adds up quickly if extended) and the Geithner USD put in place?  Moreover, the US election ahead is very likely to impact the extent to which fiscal stimulus can be deployed against the great recession ahead and less is likely making the onus for stimulus fall even more on the shoulders of the Fed.  The problem as Keynes showed is that monetary policy is largely ineffective as a stimulus response in a liquidity trap…hence the emphasis should be on fiscal policy stimulus.  Well we may be getting ourselves set up for a repeat of the Great Depression policy errors.  


With more USD printing in a liquidity trap with fiscal policy in a straight jacket and possibly tightening (if Bush tax cuts expire in January as legislated), the USD has further to fall, especially given the ECB’s and Eurogroup’s stagger over a European rebound.  However, what is different post-G20 than pre-G20 is the easy money has been made shorting the dollar…now you might find the Fed on the other side of the market in future dollar probes of the lows against the euro and yen, as well as every other major central bank acting in coordination.


David Gilmore


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