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Markets misread US strong dollar policy-Feldstein

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  • Markets misread US strong dollar policy-Feldstein

    Markets misread US strong dollar policy-Feldstein
    January 6, 2006 (Reuters)

    A misunderstanding by financial markets of the so-called "strong dollar" mantra preached by U.S. officials is helping keep the U.S. currency overpriced and contributing to bloated external deficits, Harvard University economist Martin Feldstein said on Saturday.

    Speaking on a panel on the U.S. current account deficit at the Allied Social Sciences Conventions, Feldstein outlined several factors that are holding the dollar at an overly high, and unsustainable, level.

    Repeated statements by U.S. officials in support of a strong dollar "are a nice slogan, but that's all it is," said Feldstein, who is also head of the private National Bureau of Economic Research.

    Feldstein said a correct interpretation is that "we would like to have a strong U.S. dollar at home (helped by low inflation rates) and a competitive dollar in the world."

    Financial markets are "mislead" if they think there would be government intervention or a shift in the Federal Reserve's monetary policy to protect the dollar's value, he said.

    AntiSpin: The Treasury Department has been counting on foreign central banks to respond to depreciation of the bonar by depreciating their own currencies in kind, thus the rise in commodities, including gold and oil, priced in all major currencies since 2003. Since mid-2006, whenever they attempt to withdraw liquidity, the financial markets go into meltdown mode.

    Feldstein goes on to say:
    Feldstein said the sense that foreign investment will keep flowing to the United States because it is still the healthiest economy is another "error of understanding."

    Most of the money now coming into the country is for debt purchases by foreign governments, not from equity investors attracted by fundamental strength in the U.S. economy, as was more the case in the 1990s, he said.

    Private and institutional investors started to back off of U.S. investment in the early 2000s, with foreign central banks picking up the slack. Old news. What's new news is that this issue is getting a decent airing.
    Many economists regard that level as unsustainable, but the timing, trajectory and impact of any adjustment process remains subject to vigorous debate.

    "Mussa said opinions on issue are typically split between the Alfred E. Newman "What Me Worry?" school, and the Chicken Little "The Sky is Falling" contingent."

    The Chicken Little crew includes, famously, the head of the IMF. The connection between the dollar and world financial markets became clear mid-2006, when markets started to melt down on the heals of disorderly dollar selling:
    IMF acts to avoid markets meltdown
    May 14, 2006 (Guardian UK)

    The International Monetary Fund is in behind-the-scenes talks with the US, China and other major powers to arrange a series of top-level meetings about tackling imbalances in the global economy, as the dollar sell-off reverberates through financial markets.

    Amid tumultuous trading, which sent the dollar to its lowest level in a year against the euro in late trading on Friday and gave the FTSE its worst day for three years, the IMF was working privately to exercise its new powers to bring decision-makers together.


    "We are in meltdown mode," said David Brown, chief European economist at Bear Stearns. 'It's all being whipped up into a bit of a selling frenzy. The dollar has a massive portfolio of negatives against it: it's the long-term problems of the trade deficit, and the government's budget deficit.'

    Bloom warned that 'phase two' of a sell-off would cause turmoil in the equity markets, as on Friday, when both the Dow Jones and FTSE saw sharp losses. 'I'm expecting an increase in volatility and uncertainty across the board,' he said.

    Brown added that the dollar's woes were likely to be exacerbated by central banks shifting their reserves towards other currencies, including the euro. 'Asian central banks have been buying fistfuls of dollars as the flipside of their massive current account surpluses. They're long dollars.'

    He added that with the US current account deficit with the rest of the world worth 7 per cent of its GDP in 2005, the White House and the Federal Reserve would probably be happy to watch the dollar decline. 'I don't think Washington's going to be concerned,' he said.
    By June 2006, another leader of the so-called Chicken Little crew–also Harvard man, but a history versus an economics professor–pointed to the connection between the dollar selling and volatility in the financial markets: global currency and debt speculation by hedge funds.
    Hedge funds vs. central bankers
    June 19, 2006 (Niall Ferguson - LA Times)

    Will inflation, deflation or recession win in the coming months?

    IT WAS SUPPOSED to be a summer of love — or at least of low volatility. Just two weeks ago, London hedge fund managers headed to the country for Hedgestock, a two-day event billed as "a Festival of Networking for the Hedge Fund Industry." As at Woodstock, the Who topped the bill. The difference was that at Woodstock, the audience was high, whereas at Hedgestock, only their net worth was high.

    The bigger the party, the bigger the hangover. By the close on Wednesday, there wasn't a single stock market in the world that hadn't fallen. Emerging markets, including Brazil, Russia and India, took the biggest hits. Along with China, these were supposed to be the BRICs — Big Rapidly Industrializing Countries. This month they dropped like bricks.

    ... apparently uncoordinated global tightening of monetary policy effectively shears the hedgies. For years they have been making stupid money by borrowing from central banks at near-zero rates and taking long positions in any market with momentum. "Too accommodative" central banks meant one-way bets and low volatility. Now it costs to borrow, and volatility is back.
    But a deal was worked out and that round of dollar selling and market volatility ended. We had another dollar sell-off event the day after thanksgiving 2006, followed again by a period of financial market volatility. This theme of dollar sell-offs and financial markets reaction is the background for the 2007 stand-off between the markets and the Fed, as the Fed worries about wage inflation and Wall Street worries that the Fed will send the economy into recession in an attempt to avoid wage inflation from transmitting all-goods inflation into a self-reinforcing inflation cycle.

    Curiously, of all of Niall Ferguson's LA Times columns, this is the only one no longer available via the LA TImes archives; the iTulip Daily News reference is the only one available on the Web. His article Sinking Globalization PDF is required reading for anyone trying to understand the risks of globalization fueled by global hyper-speculators, a theme Ferguson writes on frequently.
    Ninety years ago this May, the German submarine u-20 sank the Cunard liner Lusitania off the southern coast of Ireland. Nearly 1,200 people, including 128 Americans, lost their lives. Usually remembered for the damage it did to the image of imperial Germany in the United States, the sinking of the Lusitania also symbolized the end of the first age of globalization.

    From around 1870 until World War I, the world economy thrived in ways that look familiar today. The mobility of commodities, capital, and labor reached record levels; the sea-lanes and telegraphs across the Atlantic had never been busier, as capital and migrants traveled west and raw materials and manufactures traveled east. In relation to output, exports of both merchandise and capital reached volumes not seen again until the 1980s. Total emigration from Europe between 1880 and 1910 was in excess of 25 million. People spoke euphorically of “the annihilation of distance.”

    Then, between 1914 and 1918, a horrendous war stopped all of this, sinking globalization. Nearly 13 million tons of shipping were sent to the bottom of the ocean by German submarine attacks. International trade, investment, and migration all collapsed. Moreover, the attempt to resuscitate the world economy after the war’s end failed. The global economy effectively disintegrated with the onset of the Great Depression and, after that, with an even bigger world war, in which astonishingly high proportions of production went toward perpetrating destruction.

    It may seem excessively pessimistic to worry that this scenario could somehow repeat itself—that our age of globalization could collapse just as our grandparents’ did. But it is worth bearing in mind that, despite numerous warnings issued in the early twentieth century about the catastrophic consequences of a war among the European great powers, many people—not least investors, a generally well-informed on foreign affairs.
    It's well worth your time to read Ferguson's take on Globologna.
    Last edited by EJ; 01-07-07, 05:07 PM.

  • #2
    Re: Markets misread US strong dollar policy-Feldstein

    ferguson did a study of risk premia in european bond markets from the early 18th century to the early 20th century. after the close call of the napoleonic wars, when the british perpetual went from par down to about 50, the british gilt market got spooked whenever there was a geopolitical flare up. then, about 1870, it started to calm down, becoming - perhaps- complacent. thus, over 3 weeks after the assassination of archduke ferdinand in 1914, the bond had acquired a risk premium of 1 basis point, going from iirc 3.3% to 3.31%. 7 days later all the european bond markets CLOSED! risk perception can sure change fast.


    • #3
      Re: Markets misread US strong dollar policy-Feldstein

      So what is likely to precipitate a complete collapse? Take us back to exactly the same scenario as the early years of the past century?

      This turned up in The Sunday Times here in the UK.

      Israel plans nuclear strike
      Air force squadrons are training to blow up Iran's uranium-enrichment facility using low-yield nuclear “bunker-busters”, according to several Israeli military sources,00.html

      We also hear that several US government departments are in the process of moving out of Washington DC to protect themselves from the consequence of a nuclear strike on the capital; something not needed during the worst of the cold war....

      The headline should have read The White house plans nuclear strike. Why? We all know that Israel cannot contemplate such action without the full approval of the White House.

      And, how come we here in the UK are seeing such headlines when you in the US are clearly not?

      In my humble opinion, we are on the brink of observing the most disastrous foreign policy decision ever made, making the Iraq debacle look like a Sunday afternoon picnic. And, worse still, preparing for a nuclear strike on DC shows the utter irresponsibility of the proponents of the whole idea.

      Wake up America, before it is too late.


      • #4
        Re: Markets misread US strong dollar policy-Feldstein

        during the cold war there was no preparation for a strike on washington because mutual assured destruction implied it wouldn't really matter. a terrorist nuke delivered by van to the center of washington, however, would make such preparations relevent.