Currencies | Nov 12 2009
ï»¿By Greg Peel
The argument goes that the US dollar will – must – depreciate over time given the sheer weight of America’s debt burden coupled with a belief that recovery in the world’s largest economy will be slow, particularly compared to developing economies. A gold price now soundly over US$1100/oz is testament to that. But while gold is now about US$100 higher than its previous high, a dollar index stuck on 75 is still holding above last year’s pre-Lehman low of 72.
When the US dollar hit its low early last year gold kissed US$1000/oz before retreating as investors liquidated to cover stock losses. But gold is not only higher now in US dollar terms, it’s higher in most currency terms, meaning it is rallying as a hedge against all fiat currencies and not just the greenback.
It is a well known fact that world forex traders are collectively holding the largest dollar short positions ever recorded, which is one reason the US dollar should find it difficult to fall heavily and probably one reason why it seems currently stuck around 75, albeit testing the market’s patience. But another reason the dollar may not be falling despite gold’s rise is central bank intervention – whether overtly or covertly and whether coordinated across the globe or not.
Most vocal in their angst over a weak greenback have been the Europeans, and loudest among them have been the Germans. Germany was the world’s biggest exporter in 2008 but that status is under threat from a strong euro, particularly given China’s currency is pegged to the dollar and thus not appreciating with the euro. The euro hit US$1.60 at the US dollar’s nadir in 2008, but more recently it is having difficulty breaching US$1.50. To date, the European Central Bank has not made any indication it intends to support the dollar to constrain the euro just yet.
But central banks do not always want to telegraph their actions, lest they cause a panic that is otherwise disruptive in the opposite direction. If the ECB is actually trying to hold the dollar below US$1.50, then it wouldn’t be lying – just being necessarily clandestine. The intention would simply be stability. If the ECB, or any central bank, really wanted to move a currency significantly, then it would tell the world and then do nothing, because the world would do it for them.
Russia’s central bank, on the other hand, has made no secret of its attempts to stem the rise of the rouble. The rouble was crashing dangerously post Lehman before the central bank stepped in, and now the currency has rallied back 8.5% or half of its GFC losses. On Tuesday, Russia bought 700 million US dollars against the rouble and has notified its intentions to lower interest rates. Rates have already been lowered 3.5% to 9.5% since April.
As the high interest suggests, Russia has become a favoured carry trade investment destination, backed by its vast supplies of oil and gas. One can borrow US dollars at near zero and invest in Russia at a vast positive carry.
Is anyone else out there fiddling with their currency? Japan is also in a difficult situation, albeit Japan’s 0.25% cash rate is close to that of America’s. It is also a carry trade source, but still yen appreciation against the US dollar is affecting Japanese export competitiveness.
In Vietnam, the problem is with gold. Rampant gold speculation amongst the gold-mad Vietnamese has meant heavy selling of the dong to buy US dollars to buy gold. Yesterday the price of gold in Vietnam was 27.5 million dong per tael (hello?) which is about US$1283/oz. The reason the Vietnamese price is out of whack is because mid last year the Vietnamese government banned the importation of gold in an attempt to narrow the trade deficit.
Now the government will lift the ban on gold importation in order to save the dong, which in a forward basis is the weakest it’s been in 16 months.
Oh what a tangled web we weave, except that no one’s particularly trying to deceive.
This means, for what it’s worth, that the Vietnamese will no longer be supporting the US dollar, while all about the concern is the need to do exactly that. Even the Reserve Bank of Australia has sold some of the Aussie it bought when the currency crashed from near parity to the low sixties post-Lehman, in other words supporting the greenback, and has noted in its monetary policy statements that a rising Aussie acts as a pseudo interest rate rise given its dampening of export receipts. Two interest rate rises have helped the Aussie back to US$0.93, and the RBA will take the Aussie level into consideration before deciding on a third.
Given the US stock market and the US dollar have this year been moving in (opposite) lock-step, any move by central banks to stabilise the reserve currency in theory will hold back further rallies.
But central banks are between a rock and a hard place. To support the reserve currency they must sell their own currencies which (with perhaps the exception of the UK) should be more valuable on a current account and fiscal deficit basis. It is potentially a losing trade. But to allow their own currencies to appreciate means killing off local export industries.
The sensible approach – and what is probably already unstated, coordinated global central bank policy – is to allow the greenback to weaken gradually. But this will require a counterbalancing offset from China, which needs to allow its pegged currency to gradually appreciate. Chinese exports will otherwise kill off everybody else’s exports.
And yet while China might be winning the battle with its rapid, stimulated domestic economic growth, it is yet to win the war that sees its export industry return to power. In other words, there is little incentive for China to appreciate its currency other than very, very slowly, as noted in yesterday’s China Locked Into Stimulus Despite Growth.
How do we ever get out of this mess?