from Follow the Money

Apparently, a global slowdown driven by a slowing US is GOOD for the dollar

September 1, 2006

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The (unnamed) “analysts” have spoken.    The yen won’t rise above 113 v the dollar even if the US economy slows significantly, slowing the global economy.    Ahmed and Lindemayer report in today’s Wall Street Journal:

“Slower global growth also will encourage Asian central banks and governments to stand in the way of a sharp appreciation of their currencies.   Any fall in the dollar would be limited to 113 yen, and any rise in the euro would peak at 1.30, after which the dollar would recover, said analysts.” 

How do the analysts know that the yen won’t breach 113, I might ask?

A few years ago, growth and interest rate differentials were good for the dollar.   Now apparently slow US growth (and falling interest differentials) are good for the dollar.   

The first point – than Asian central banks will intervene if their currencies start moving up -- is probably right.   I never knew that the Japanese were defending the yen/ dollar at 113 though.    That would still leave it very weak in real terms against the dollar – and exceptionally weak in real and nominal terms against the euro.  See the analysis of Teis Knuthsen of Danske Bank.  At least the part of his analysis that covers the euro/ yen and the overall real value of the yen. I am less convinced that the dollar/ yen is close to fair value than Knuthsen.  

That Asia likely will try to prevent Asian currencies from appreciating against the dollar as the US slows –and thereby keep Asian currencies exceptionally weak against Europe is a bit of a problem for the global economy.  I cannot think of a better way to undermine European support for our current brand of globalization than a persistent misalignment between the euro (and other European currencies) and the main Asian currencies. 

Indeed, I increasingly think the Asia/ Europe exchange rate more out-of-whack than any other set of prices in the world economy.  OK, it is second biggest price misalignment.  The gap between oil prices and the oil states currencies is number one (together with the related gap between oil state revenues and oil state spending).   But Asia/ Europe is becoming a close second.

Consider China/ Europe (most of Europe follows the euro).    China has resisted the natural pressure to appreciate against the dollar from its export success and from the rapid growth in its productivity.    But at least it hasn’t depreciated in real terms against the dollar.  

It has depreciated big time against the euro even as Chinese productivity growth soared.  The data is in my China testimony.  That depreciation is a big reason why overall Chinese export growth has consistently exceeded the growth in Chinese exports to the US.

Consider Japan/ Europe.  The yen is quite weak in real terms against the dollar.   But it is exceptionally weak in both nominal and real terms against the euro.   It isn’t an accident that European automobile firms are feeling a bit of heat.   Forget labor market rigidities.  Think currencies.  There is a big difference between 100 and 150 for the euro/ yen.

The net effect of Asian weakness vis a vis the Europe?  Asia’s trade surplus with Europe has grown dramatically over the past 18 months.   That has offset its higher oil import bill.  More than offset it.  And kept overall Asian export growth up even as Asian export growth to the US has slowed somewhat.    

As a result Asia’s overall current account surplus is still growing even as Asia’s oil import bill soars. 

In other words, euro strength v. Asia helps the Asian economies generate the funds that allow them to finance the United States deficit.   The funds Asia earns selling to Europe – often selling goods priced in dollars – are largely channeled back to the US.  

I think China keeps roughly 70% of its reserves in dollars, maybe a bit more.  It has more money to put to work than anyone else right now.  Most of the Asian surplus still flows to the United States.

That is a slightly different account that the account put forward by Stephen Jen.  I don't think a strong euro against key asian currencies is a natural result of globalization (somehow, europe developed a comparative advantage producing financial assets just at the right time).  It is a function of the particular kind of globalization -- one dominated by Asian intervention in currency markest -- that we now have.   

But that doesn’t mean Jen’s funneling hypothesis is all off.  

The euro is strong against the yen because of a revived yen carry trade, with investors now borrowing yen to buy euros as well as dollars.  And some folks find a trend and like to go for a ride.  The euro is also strong against the yen because the oil exporters are generating a huge surplus selling oil to the big Asian economies that they basically invest in either Europe or the US, not back in Asia.  China won’t let oil exporters park their surplus in yuan.  

And yen interest rates are still too low to make the yen attractive.    So the “dollars” that Asia pays to the world’s commodity exporters end up flowing either back to the US or into Europe.  That flow is particularly visible in the UK; the pound has reemerged as a key reserve currency.  When the oil exporters invest in Europe, the oil exporters are selling – in part – dollars earned selling oil to Asia for euros, pounds, Swiss franc and Swedish krone.  

That has an impact. 

Best I can tell, that is.

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