March 18, 2010After weakening through most of the past decade, the dollar has appreciated significantly against the euro and the pound sterling, the two major European currencies, over the past three months. Down from a peak of $1.51 on December 3, the euro now trades at $1.37. And the pound fell from $1.68 last November 9 to just over $1.50 earlier this week. The previous bout of dollar strength was in October 2008 when the euro dropped to below $1.25, following the collapse of Lehman Brothers. On the other hand, the recent appreciation of the dollar has been due to fears of adverse developments on the other side of the Atlantic. Concerns are growing that the economic recovery in Europe may be sputtering, and that production may stagnate or even decline again, in coming quarters. Furthermore, British elections likely to take place next month may result in no party holding a majority, and the resulting policy uncertainties have raised fears that U.K. debt may be downgraded. And despite announcements of support by the European Union for Greece, concerns that Portuguese and Spanish sovereign debt may come
Weak European Currencies Rather than a Strong Dollar What next for the dollar? Even though the U.S. economy has problems of its own – an unemployment rate near 10% despite an economic recovery which began last summer, and surging fiscal deficits with no correction in sight – it still serves as the safe haven when faced with global problems. And I see no quick end to Europe’s problems. The next U.K. government – whether formed by Labor, the opposition Conservatives, or by a coalition of parties – will remain under pressure from rating agencies to reduce fiscal deficits by raising taxes and cutting spending, even though the economy threatens to fall back into recession. And as long as that threat is real, it will keep the pound sterling weak against the dollar. . And in the Eurozone, while Greece successfully raised EUR 5 billion (almost $7 billion) through a 10-year bond placement earlier this month, the funds were raised at an interest rate of 6.25%, over three percentage points higher than that paid by the corresponding “risk-free” German paper. Since the Greek public sector has to repay, or roll over, an estimated EUR 23 billion during April and May alone, the recent successful bond placement does not end Greece’s funding problems, by any means! And with a Greek bailout immensely unpopular in Germany, German authorities have taken the position that an actual transfer of funds to Greece does not have to take place unless Greek officials are unable to raise funds in the capital markets. However, as he explained on the “The Charlie Rose Show” last week, Greek Prime Minister George Papandreou believes that his country should not have to pay a high premium to borrow since it is a member of the Eurozone. The tacit disagreement between Greece and Germany will probably persist well into the summer and put further downward pressure on the euro. Verbal Jousting with China: A New Twist And the dollar got some help at the beginning of this week from an unlikely source. Responding to President Obama’s call last week on the Chinese to pursue a “market oriented” exchange rate – code for allowing the renminbi (RMB) to appreciate against the dollar – Chinese Prime Minister Wen Jiabao insisted at a press conference Sunday that the Chinese currency was not undervalued. And “we are opposed to the practice of mutual finger-pointing among countries,” said Mr. Wen, expressing his irritation at President Obama’s public criticism. The verbal exchange was followed by demands by members of U.S. Congress Monday that Treasury Secretary Timothy Geithner brand China a “currency manipulator”, a label which would pave the way for the imposition of further trade sanctions against the country. Signs of rising tensions between the world’s two major economic powers led to risk aversion on the part of investors, resulting in the dollar's strength.
There are at least two dimensions to the U.S. – China dispute over the proper valuation of the RMB. The first is a class of cultures. Public criticism of China’s exchange rate policy by successive Secretaries of Treasury in the Bush administration have generally been counterproductive, resulting in a greater resolve on the Chinese part not to appear to comply with a U.S. demand. And with the U.S. criticism last week coming from the President himself, The second dimension relates to what the two governments consider to be their proper roles in the global economy. For President Obama, a rising economic power such as China should allow its currency to appreciate, and boost domestic consumption rather than depend largely on exports for its continued economic growth. From the Chinese point of view, the global financial crisis originated in the United States as a result of easy monetary conditions and a lax regulatory framework. And while the U.S. dollar depreciated on a trade-weighted basis after March 2009 helping U.S. exports, Chinese officials note in private conversations, the RMB has remained stable since July 2008. From the Chinese perspective, the government was a contributor to global stability rather than a manipulator of its currency for temporary advantage. Such nuances are easily lost in the ongoing public dispute. Further Dollar Weakness Over Medium-TermThe dollar should resume its depreciation on a trade-weighted basis late in 2010 or in early 2011. From the U.S. side, there is little expectation of a reduction in the fiscal deficit in the face of a slowing economy, or even a double-dip. The continuation of high unemployment rates may Komal S. Sri-Kumar Chief Global Strategist Disclaimer This publication is for information purposes only. Past performance is no guarantee of future results. While the information and statistical data contained herein are based on sources believed to be reliable, we do not represent that it is accurate and should not be relied on as such or be the basis for an investment decision. Any opinions expressed are current only as of the time made and are subject to change without notice. TCW assumes no duty to update any such statements. The views expressed herein are solely those of the author and do not represent the views of TCW as a firm or of any other portfolio manager or employee of TCW. Any holdings of a particular company or security discussed herein are under periodic review by the author and are subject to change at any time, without notice. In addition, TCW manages a number of separate strategies and portfolio managers in those strategies may have differing views or analyses with respect to a particular company, security or the economy than the views expressed herein. This report may include estimates, projections and other "forward-looking statements." Due to numerous factors, actual events may differ substantially from those presented. This publication is not to be used or considered as an offer to sell, or a solicitation to an offer to buy, any security. Nothing contained herein should be considered a recommendation or advice to purchase or sell any security. TCW, its officers, directors, employees or clients may have positions in securities or investments mentioned in this publication, which positions may change at any time, without notice. ©Copyright 2010 TCW Asset Management
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