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Monday, May 19, 2003

The Dollar: A Modest Re-alignment

Back to Kevin's blowing sunshine argument about the absence of a currency policy instrument. I still think the key point here is not the presence or absence of direct intervention. The US intervenes in currency markets by means of 'expectations'. Since the US Treasury is potentially the strongest player in the game, market participants try to read the tea leaves and anticipate official policy. If they do this successfully, then, in the best of circumstances there, is no need for the intervention. Of course, when we get to the 'worst of circumstances' all this changes. The US attitude to dollar policy is changing, and, if we take Bernanke seriously, we should expect more changes to come. The real push-comes-to-shove moment will come when Brussels and the ECB finally reach the conclusion that the euro is way too high, it's then that we'll see whether intervention is a thing of the past or not, especially if interest rates start rubbing against the zero limit and conventional monetary policy loses the little capacity it has left.

The dollar is expected to come under renewed pressure on the foreign exchange markets on Monday after John Snow, US Treasury secretary, suggested the long-standing strong dollar policy did not imply any view about the exchange rate. He also played down the dollar's recent fall as "a modest realignment."...........

Since the mid-1990s, the strong dollar policy has relied on rhetoric to support the exchange rate, rather than intervention or interest rate changes. The rhetoric provides reassurance that the US would not intentionally attempt to drive the dollar lower and might at some point be prepared to support it. Mr Snow has undermined that reassurance.His comments came after data showing signs of flagging growth and falling inflation heightened fears of deflation in the US.
Source: Financial Times

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