Neal Kimberley is an FX market analyst for Reuters. The opinions expressed are his own
Twenty-four years ago, major nations called for depreciation of the dollar to rebalance the global economy. Now, as another effort at rebalancing looms, the dollar will again bear the brunt — though officials will try to ensure its fall is less dramatic this time.
That’s the implication of President Barack Obama’s announcement this week that he will push world leaders for a new global “framework” in which the United States would cut its huge trade and budget deficits. Agreeing on this framework would be politically difficult, since it would require policy changes by many countries — China, for example, would probably have to rein in its explosive export-led growth.
But as the euro’s climb to a new one-year high versus the dollar this morning shows, markets are starting to think the rebalancing process may start as soon as this week’s Pittsburgh summit of leaders from the Group of 20 nations. The Plaza Accord of 1985 called for “orderly appreciation of the main non-dollar currencies against the dollar”; it was followed by central banks’ coordinated intervention to ensure that happened.
This time, with the world shakily emerging from a financial crisis, policymakers are likely to try to manage the dollar’s drop in a more low-key fashion. They are unlikely to issue an explicit call for the dollar to fall. In fact, the U.S. Treasury may continue proclaiming its “strong dollar policy” in an attempt to keep the markets calm. No one in the G20 wants to risk a freefall of the dollar that could disrupt global trade as it recovers from recession.
And in contrast to the 1980s, developing nations such as China are now challenging the dollar’s long-term role as the world’s top reserve currency. The dollar’s premier status helps the United States to obtain foreign capital and in order to keep that access, Washington is likely to encourage central banks around the world to continue holding dollars. This would require slow depreciation of the currency rather than a panicky slide. So unless policymakers completely lose control of the forex markets — which cannot entirely be ruled out — the dollar’s slide is likely to be slower and smaller than it was after the Plaza Accord, when the currency sank about 50 percent versus the yen between Sept. 22, 1985 and the end of 1987.
The overall direction of the dollar does not look in doubt, however. Top presidential adviser Lawrence Summers has said he wants a U.S. economy that is “more export-oriented and less consumption-oriented”. A lower dollar is a logical tool to achieve that goal, and letting the currency weaken would probably be faster and easier than most other big policy steps to reshape the U.S. economy, such as tax changes and health reform. The International Monetary Fund, which is advising G20 nations on economy policy, is hinting heavily at the need for currency realignment. In a report released this week, it said “current policies and the assumed constellation of exchange rates may not be sufficient for the needed rebalancing of demand.”
It added that policy reforms by the world’s big economies to restore growth “would be more effective if accompanied by a real effective renminbi appreciation, offset by euro and dollar depreciation”. An international understanding on dollar depreciation may well not be reached in Pittsburgh. A French official said last Friday that Pittsburgh would merely set the stage for future talks on foreign exchange rates. “At this stage there will not be currency discussions, but the framework that we hope to put in place…is a way of discussing later the question of exchange rates,” said the official, who declined to be named. But giving China and other developing countries more power in the IMF and the World Bank could be part of an informal quid pro quo in which China quietly undertook to resume appreciating the yuan against the dollar.
The rise of the euro as high as $1.4821, breaking the December 2008 peak of $1.4719, is a technical signal that the market thinks the dollar is increasingly vulnerable. For many traders, the break suggests a good chance of a rise to at least the psychologically important level of $1.50 in coming weeks or months. The European Central Bank might seek to limit speculation against the dollar by expressing concern about such a move. But the market does not appear to worry that the ECB could actually intervene to support the dollar. When the European Union’s Economic and Monetary Affairs Commissioner Joaquin Almunia said last week that excessive appreciation of the euro could hurt Europe’s economy, the euro fell back only marginally and briefly. The market knows that even at levels just above $1.5000, the euro would remain well below its all-time high against the dollar of $1.6038, hit in July 2008.
And any rise of the euro against the dollar in the current circumstances would probably be seen by policymakers as the result of general dollar weakness, not excessive euro strength. When euro/dollar reached its July 2008 peak, euro/yen hit a similar high; now, euro/yen is a full 35 yen lower. The Japanese may also be willing to see their currency strengthen. Before new Finance Minister Hirohisa Fujii took office this month, he said a strong yen was generally good as it boosted the purchasing power of Japanese. Fujii subsequently backed away from that comment, but speculation will remain that after sweeping to power last month, the Democratic Party of Japan may try to shift the country away from its reliance on exports and its opposition to yen strength. In the context of a G20 drive to rebalance the global economy, this could easily cause the market to think the yen should be trading stronger than 90 to the dollar.