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As the global economy gropes for a bottom, the dollar has attracted an unusual amount of attention from nervous investors. Since it peaked at 82.2 cents to the euro in the autumn of 2000, the dollar has lost as much as 11% of its value. Not a huge drop compared to, say, the Nasdaq's. But after half a decade of the dollar going nowhere but up, it comes as enough of a shock to grab headlines and create anxiety.
The dollar's decline has also come with a fair degree of volatility. The euro peaked against the dollar in February at around 96 cents, and then dropped to about 83.5 cents by July.
The greenback perked back up 2.6% on Sept. 5, mainly due to a positive report on the manufacturing front, and now the euro is worth about 89 cents.
Fears of more declines have sparked visions of a rapid, disorderly sell-off that could wreak havoc in financial markets worldwide. September will be a key month in global currency markets. "When you consider the volatility of the price action in August [a slow time in the market], and then you think about the asset allocations that will occur at most firms when everyone comes back to work in September, it seems the danger of a dollar collapse could be greater in the fall," says Tim Stewart, chief currency strategist at Morgan Stanley.
HYSTERIA. The dark scenario: An additional dollar decline of, say, 10% or more in a single week, like what happened to Asian and East European currencies in the fall of 1998, could prompt investors to abandon all faith in the possibility of a U.S. recovery. Indeed, Stewart is betting the dollar will continue to weaken and that the euro will hit 93 cents by the end of September.
Is he predicting disaster? Quite the contrary. He and many U.S. currency experts believe the recent fears about the dollar are mostly a tempest in a teapot. Nearly everyone agrees that the dollar has been overvalued compared to key currencies for some time now. And some signs indicate that the U.S. economy may have bottomed out in recent weeks.
Fears that a weak dollar would de facto cause inflation are also overblown
What's far more likely, experts say, is a fairly orderly retreat from the dollar's consistently high levels against the euro to around parity by the summer of 2002. Why? Well, even though the U.S. economy remains under a cloud, Europe's outlook isn't any better. At the same time, the dollar will probably remain fairly stable vs. the Japanese yen. If the perpetually sluggish economic picture in Japan doesn't do it, the Japanese Finance Ministry is likely to do what it can to keep the yen from strengthening.
Fears that a weak dollar would de facto cause inflation are also overblown, most economists agree. "The direction of inflation from 1985 throughout the 1990s was downward," says Christine Callies, chief strategist at Merrill Lynch. "Yet the dollar deflated from 1985 to 1990 and then sort of bumped along at the bottom for a while."
RESIDUAL EFFECT. If anything, pressure has increased in recent months on the Bush Administration from manufacturers to push for a weaker dollar. The manufacturing sector, hard hit by the current slowdown, is hoping the dropping dollar will increase exports. Retailers who import a lot from abroad and bankers whose investments are heavily dollar-denominated would be just as happy if the dollar didn't fall much from here.
To be fair, part of today's greenback hysteria is a residual effect from the Clinton Administration's crusade for a robust dollar during the '90s. Truth is, the Clintonites nabbed credit for an economic phenomenon that would have occurred with or without its "strong dollar policy." Robert Rubin, longest-serving Treasury Secretary under Clinton, initiated that policy in 1995. All that meant was that the U.S. Treasury wouldn't talk down the dollar as it had in the early '90s and would stop threatening to weaken it if Japan didn't open up its markets to U.S. trade, according to Stewart.
"After declaring its strong dollar policy, the only time the [Rubin] Treasury intervened in the currency markets was to weaken the dollar, once against the yen in the summer of 1998, and more recently against the euro in September, 2000," says Lara Rhame, currency analyst at Brown Brothers Harriman. Since March, 1995, the dollar appreciated 68% against the German mark, which is now incorporated into the euro.
The Fed is more concerned with jump-starting capital spending than with the dollar
In fact, thus far Treasury's response to the dollar has been typical -- hands off. Despite the awkward political posturing of
Treasury Secretary Paul O'Neill -- he had to step back from
public musings that he thought a weaker dollar might be a good
idea -- the Treasury is letting the currency adjust according to the economic fundamentals of the U.S. vs. Europe and Japan. Now that the dollar is weakening along with U.S. economic fundamentals, the O'Neill Treasury can't come out and say it supports the phenomenon -- that would be like coming out against baseball and apple pie.
LOUD MESSAGE. Still, the Federal Reserve is keeping a wary eye on the dollar in case a sell-off might trigger a huge rush for the exits by foreign investors. But the central bank is far more worried about jump-starting capital spending than it is about propping up the dollar. The Fed is giving no sign that it's going to abruptly stop or reverse its current easing cycle and instead raise rates to prop up the dollar. And since neither the Fed nor the Treasury mucks much with currency unless there's a crisis, the fact that they're letting the dollar slide should speak volumes to investors about policymakers' concerns over the economy's weakness.
The next few weeks are crucial. A weaker-than-expected U.S. outlook could aggravate a capital flight from the U.S. to Europe, or wherever the best growth prospects are. "If the view is that the U.S. is going to grow by 3% or 4%, there will be more confidence that the current weakness in the dollar is a low," says Stewart. "If the view of the U.S. is for [gross domestic product] growth in the low 2% range with a longer extension of the cyclical downturn, then you might see more significant currency shifts of 10% or more [devaluation of the dollar]."
In the end, it all comes down to how investors view the potential for a U.S. recovery, especially compared to the economic outlook for its largest trading partners. "The biggest thing the dollar has going for it is the comparison to what else is out there," says Bernie Schaeffer, chairman of Cincinnati-based Schaeffer's Investment Research.
With revised GDP growth in the second quarter at just 0.2% and the summer drops for the U.S. stock market, the domestic economy certainly looks less fabulous in comparison to Europe than it used to. But if the third quarter proves to be the bottom in the U.S, the euro won't end the year above 95 cents -- and the dollar's slide has likely ended.
Popper covers the markets for BW Online in our daily Street Wise column Edited by Beth Belton
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