The question many, if not most U.S. investors are wondering about, is what impact will Thursday's central bank effort to loan dollars and to buy up euros have on the value of the dollar and stocks on their home shores?
Well, in the short-term, the action will at minimum help slow the euro's decline versus the world's other major currencies; at best, it will stabilize the currency--but the latter isn't likely. For those who missed it, the European Central Bank, in coordination with the U.S. Federal Reserve, the Bank of England, the Bank of Japan and the Swiss National Bank have agreed to conduct three U.S. dollar liquidity-providing operations with a maturity of about three months covering the end of the year.
Why are the major central banks doing this? They want to help maintain credit market liquidity in Europe, keep the euro's decline orderly, and avoid large, brutal currency moves that can trigger commercial instability by making it harder for business executives to plan, among other negative consequences. For example, it's hard for a U.S. CEO in Kansas City, Mo., to decide what prices to charge for his product in Europe if he doesn't know what the euro's value will be: $1.40? Or $1.20?
The euro traded higher against the U.S. dollar on Thursday at mid-day, up 1.19 cents to $1.3873.
Why are institutional investors becoming nervous? Institutional investors are becoming increasingly jittery about lending dollars in exchange for euros or extending loans to Europe's private sector banks because they believe the euro will fall versus the world's other, major currencies, and probably the dollar, in the next three to six months.
Why do institutional investors believe the euro will fall? You guessed it: the ongoing problem of European government debt. Institutional investors are concerned that Greece, and possibly Italy, Spain and Portugal will need a bailout of some type -- most likely in the form of eurozone country or European Union loans. That will increase the number of euros in circulation, reducing the value -- or price -- of the euro.
Does that mean the dollar will rise versus the euro? Probably. The U.S. has its own, large budget deficit problem -- and a nasty, ongoing partisan fight between Democrats and Republicans -- but at least it has the benefit of fiscal union. Europe doesn't: it has monetary union, but not fiscal union. In other words, all other factors being equal, a big budget deficit with fiscal union, sort of (U.S.), beats a big budget deficit without fiscal union (Europe).
What does it me for me, the U.S. investor in stocks? Good question. Short-term, the effort to maintain liquidity in Europe and prop-up the euro will hurt U.S. stocks, but in the long term, if -- and this a big if -- the coordinated central bank intervention maintains credit market liquidity and results in an orderly decline of the euro, the U.S. and European economic recoveries will continue, and the world will have avoided another Lehman Brothers-type event that worsened the global financial crisis in late 2008 into early 2009. And if that long-term scenario ensues, that would be bullish for the U.S. stock market.