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Recent Dollar Strength: Reasons & Implications / Dollar intervention? / Man, that's a lot of people

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August 11, 2008 – Comments (4)

Why is the U.S. dollar so strong right now? 

The U.S. dollar has taken off like a rocket over the past several weeks, rising from 1.60 versus the Euro to today's 1.50 and from less than 100 versus the Yen to today's 110.  The main reason for this shift is not stronger than expected performance by the U.S. economy or any supportive or responsible actions being taken by the government or the Federal Reserve, our politicians are still spending money like drunken fishermen after a big catch, the Federal Funds rate is still as low as ever, and the Fed / Treasury are still printing money as fast as they can to bail out or lend to any financial institution that wants it. 

The recent dollar strength can completely be attributed to the fact that Western Europe and Japan are experiencing much greater economic weakness than most analysts were forecasting.  Currencies are all relative, even though the U.S. isn't really in any better shape than it was a month ago Europe and Japan are in worse shape.

Now as I have said in the past, I'm no gold bug.  I would much rather use natural resources, like oil and natural gas, that get consumed to play the weak dollar than gold which just sits there, but a number of the gold bug websites are starting to talk about how the current dollar strength reeks of central bank intervention (see article: Gold Money - Mystery Solved).  Do I think that is what is happening right now?  It's tough to say.  The dollar has fallen a lot and central banks have intervened to help freefalling currencies in the past.

What are the implications of a stronger dollar?

So for now the dollar is rapidly gaining strength.  What are the implications of this?  Well for one, U.S. citizens are getting some relief as the price of oil, which is priced in dollars, has started to decline.  This is good news for the Federal Reserve because it means that it will be able to keep interest rates at their current low level, or even eventually lower them if growth continues to slow, and not have to hear all of the inflation hawks squawk about how they should be raising rates.

While the drop in the price of oil (which I strongly believe is only temporary) will certainly help the economy in the short run, the United States has many more problems than just expensive oil.  The jobs market is still a mess and credit is still tight.  I suspect that the economic weakness that we have been seeing will continue. 

One aspect of a stronger dollar that I don't hear talked about much is that it will actually make goods that are produced in the U.S. more expensive for foreigners.  Exports have been one of the few things that have been keeping the U.S. economy afloat while domestic consumption has slowed.  If exports begin to slow too, the GDP could really fall off of a cliff.  The government had better be careful what it wishes for, a weak dollar and the strong export numbers that go with it has been one of the few things that the U.S. economy has had going for it lately.  Eliminate that and things would look really bad.

Regardless of why the U.S. dollar is rallying right now, I find it unbelievably hard to see how this is the beginning of a new, long term era of dollar strength.  It is difficult to say how long the slowdown in Europe or Japan will last or whether it will be as bad as the one that we are likely to experience here in the U.S., but once this upward burst in the dollar is over I expect the long-term fundamentals of a huge current account deficit and a massive Federal debt to once again cause the dollar to continue to slide to even lower lows.  It certainly is trendy to talk about how the dollar has seen its lows and how it will rally significantly from here.  Time will tell.

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Olympics

To me, last week's impressive opening ceremony for the XXIX Olympics (the next one XXX, will be pretty funny to us Americans...), is that it is a microcosm of China itself.  While some use of technology was obviously involved there was a TREMENDOUS amount of man (and woman) power used in the ceremony.  I was blown away when those boxes that were rising and falling in patterns opened up and there was people inside.  I thought for sure that it was computerized.

To me, the unbelievable number of Chinese citizens that were involved in the opening ceremonies just reinforces the whole Chinese investment thesis at a time when one could easily be deterred by the recent 50% drop in its market. China has so many people that it will continue to grow and consume a tremendous amount of resources unless its government does something to really mess things up. 

On a related note, I consider myself to be fairly informed when it comes to the world and I was shocked by the number of tiny countries that are involved in thegames that I have never heard of.

Tha's a lot of people

Deej

4 Comments – Post Your Own

#1) On August 11, 2008 at 4:42 PM, wrote:

Why would the central and commercial banks want to manipulate the American Dollar's Strength????   Would it be befinifical for Citibank -$3/ share loss if the dollar was worth more than an equity, commodities, and gold?????

 

Of course, since all they own and owe is paper dollars, debt, debt on previous paper dollars, debt on their previous debt, and nothing else.

 

andrew

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#2) On August 11, 2008 at 5:19 PM, TMFDeej (99.46) wrote:

Thanks for the comment, Andrew. The last time that I checked, the Federal Reserve was the one that sets the United States' monetary policy, not investment banks.

A stronger U.S. dollar helps the Fed tremendously in the short run because it was stuck between a rock and a hard place, with some people screaming for a low Funds rate to help fight the recession on one side and the inflation hawks clamoring for higher rates to fight inflation on the other.  A stronger dollas has caused the price of oil to drop and enabled the Fed to leave rates at their low level.

Furthermore, Europeans are annoyed that the strong dollar is hurting their exports at a time when many Western European economies are slowing.

Dollar intervention in the short run solves a lot of problems on both sides of the pond.  I'm not saying that this is what's happening right now, just that it certainly benefits the parties that could intervene.

Deej

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#3) On August 11, 2008 at 6:13 PM, DemonDoug (92.48) wrote:

the us dollar is "strong" only because oil has dropped with a demand drop from china.  see my most recent blog post for a more detailed discussion.

and yes market manipulation definitely plays a part.

always remember though that while the fed can engineer a stronger dollar, their mandate is to always weaken the dollar.  (inflation targeting of 1-2% a year is mandating a weaking of every dollar by that much).

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#4) On August 12, 2008 at 6:08 AM, DemonDoug (92.48) wrote:

heh, deej, the federal reserve is owned by it's member banks.  And who sits on the board of directors of the bank of NY?  The CEO of JPM for one, and the CEO of Lehman Brothers - among other banker CEO's of course.  Goldman Sachs and JPM are basically proxies for the Federal Reserve, so while technically you are right the Fed sets the policy not the IB's, to say the IB's don't have any influence is folly.  One could argue that JPM and GS have more influence on Fed policy than pretty much any other organization out there (hell we know congress doesn't have the balls to stand up to the Fed that they freakin are supposed to be overseeing).

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