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Thursday, August 21, 2003

The Dollar Revisited

Ok, I think it's time for a quick reality check on the dollar, since it's clear that for some time now the wind direction has changed and what went down is now coming up. Now what better way of doing this than by dropping-over to take a look at the Big Picture. ( Of course economics news isn't all you will find, admirers of Big Arny may well also want to check out this link ). Now according to our man Barry:

A sustained dollar rise certainly raises questions about the health of the rest of the World's economy; When the buck was weak, the industrial sector had a nice currency based rise in Q2 earnings; Now we are looking at the potential flipside of the issue. The WSJ quoted Derek Halpenny, a currency economist at Bank of Tokyo-Mitsubishi in London: "A significantly stronger dollar would raise concerns over the incipient recovery in the U.S. manufacturing sector." About a third of the net gains in S&P 500 companies was due to currency factors, with revenues up 7.4% versus estimates of 5.5%, according to First Call’s Chuck Hill. While I agree with that assessment, its worth noting that a stronger U.S. currency means that foreign investors are placing their bets in U.S. dollar assets – and that helps to keep the markets rising. When the dollar was weakening prior to the war, we saw a lot of repatriation of overseas assets.

Barry goes on to quote Forbes' Gary Shilling who was sayin back in June thet the "Odds are, though, that the dollar's weakness is only temporary. The U.S. is too strong economically for the dollar to stay down much longer. Besides, whatever problems we face will not be cured by foreign exchange rates . . . ". He might well have also cited another commentator who was saying back in May that:

I think the important thing here is to distinguish between the short and the medium term. Short-term people are buying euros, and European bonds, not principally for the interest rate differential, but because of the US policy of lowering the dollar in relation to the euro, and because this policy convinces them that the dollar will have to fall, and this adds to the momentum. At the same time the absence of any evident willingness to resist from Frankfurt and Brussels only encourages this process. But once we look out to the medium term (say 18 months to two years) process can only unwind. It can only unwind since the relative economic strengths of the two regions can only change in the direction of US positive.

The only real problem here is that I thought the euro strength would hold longer than it has. Mind you, we still don't know, the dollar decline may not be done yet, although one day it will be. There is too much 'noise to signal ratio' at the moment. Part of the problem is reading Greenspan's Fed language (Problem for market participants I mean. I think I understand only too clearly the problems they must be having down at the Fed, the only way is 'duckin and weavin' zigga-zagga style, since there is no easy and obvious solution to this. The problem for the market participants is that they assume there is, and Greenspan can't tell them they're wrong). One minute they're with the unconventional tools, then the deflation threat is receding, then rates are going to stay low for some time, then........... Another serious deflation warning from the Fed and the dollar drift up could be stopped dead in it's tracks, and looking at the output gap just such a warning must be on the cards in the not too distant future.

Before leaving our erstwhile film fan, I simply must comment on his very interesting VIX chart. Now VIX stands for market volatility index and, as Barry explains, low volatility can be associated with market complacency, which itself may often be thought to indicate the calm before the storm of a market reversal. I'm no markets specialist, but sometimes I can't help taking the risk of sticking my neck out: looking at this chart, and thinking about everything we already know (both economically and geopolitically) I can't help feeling that an imminent reversal is just what we may be looking at.

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