Does the U.S. want a weak or strong dollar? That’s the $64,000 question for currency traders. Earlier this year, a weakening dollar was touted as a salve for U.S. industrial exports. Yet at the weekend meeting in Dubai, the G7 industrial countries issued a statement calling for “more flexibility in exchange rates” – meaning a weaker U.S. dollar. All the while, Treasury Secretary Snow affirmed the U.S. commitment to a strong dollar policy.
Which is it?
The G7 comments were consistent with recent White House statements. The U.S. has been pressing Japan and China to stop intervening in their currencies. By artificially keeping the Yen and the Yuan cheap, these nations can export goods attractively priced to U.S. consumer markets.
The combination of a new Japanese cabinet (which might be willing to let the Yen float) and the G7 statement worked to embolden traders, who bought the Yen versus the Dollar. Asian currency prices surged and stocks tumbled on fears of reduced exports to the world’s largest economy. The Nikkei 225’s drop of 463 points – over 4.2% – was its biggest sell off in over two years.
The good news is that U.S. officials did not do anything to exacerbate the situation. There are some odd parallels to 1987 – a sharp summer spike in interest rates, changes in tax policies, a big rally in stocks, and a threat to back away from a strong dollar policy all contributed to the 1987 crash. Those factors and events sound disturbingly familiar.
Fortunately, the differences between today and 1987 argue against a new crash: The ‘87 spike in rates was from 9% to 10.5%, while the recent move was from 4.2% to 5.5%; while that’s a greater percentage, its not a rise to peculiarly high levels. The changes in tax policies were benign this time versus the threatened “Merger Tax.” And while the current rally has been substantial, it was from levels “down so long it looks like up to me.”
Lest anyone forget, Nasdaq 1,900 is still more than 3,000 points below its former highs.
The silver lining in the currency debacle is that we now know that Treasury Secretary John Snow is a student of market history: He’s been insisting there’s no change in the U.S.’s strong dollar policy (that’s his story and he’s sticking to it). Traders – at least those older than 30 – may recall that then Treasury Secretary James Baker precipitated, in large part, the ‘87 crash. In a statement over the over weekend, Baker threatened to encourage a further drop in the dollar. The next trading day was Black Monday.
It’s an old but true cliché: Be careful what you wish for, you just might get it.
Chart of the Day
Superimposing the Nikkei index onto the current Nasdaq index suggests that history might be repeating itself. The chart shows the massive bear market of 2000-2003 and subsequent rally since late 2002 (moved forward 14 years or so) has followed a strikingly similar pattern to that of the Nikkei (circa 1989).
Nasdaq vs. Nikkei
What might this mean? If history continues to repeat itself, the Nasdaq will soon be entering a larger broad trading range.
Is the Fed lying?
Quote of the Day
“Given how expectations had been building up in recent weeks, markets will be unimpressed by this. The statement does little more than reflect the views already there and highlights that this remains the key issue.”
–Gerard Lyons, chief economist at Standard Chartered Bank.
Lyons may have been aware that G7 officials had privately said that the communiqué was “more a bid to placate domestic US public opinion than a genuine attempt to engage with the Chinese authorities. A senior G7 official said there was resistance to treating China as the “root of all evil” and the country was very unlikely to succumb to public international pressure to revalue its currency.”