The road to 1.50

The week of Oct. 15-19 was one of unrelieved gloom. Everyone pointed to a litany of woes that doomed the U.S. dollar to ever-lower levels against the benchmark euro. We are usually tempted to be contrarian when “everyone” is saying the same thing, but it’s a big list and pretty convincing.

The question is, is this a crisis or not? The dollar may indeed be headed further downward, but it’s uncertainty that creates panic and a sense of crisis, and this time there is little uncertainty. In fact, the dollar’s decline has been quite orderly; it’s the corrections that have been sharp and shocking. When fear reaches panic levels, the knee-jerk reaction is to buy the safe-haven dollar, not sell it.

Regardless of newspaper and newscaster scare tactics, some of what is going on has little or nothing to do with the dollar itself. Each entry on the list of dollar woes is understandable, and none of them is fatal:

• The major stock market indices each fell more than 2.5 percent on Friday, Oct. 19, the anniversary of the biggest one-day price drop ever (22 percent) in 1987. The same day, oil futures hit an intraday high just above $90, and although the market closed lower that day, it was up 45 percent year-to-date. Meanwhile, gold reached a post-1980 high of $765.20.

• The benchmark 10-year T-note yield closed at 4.401 percent, only a few points off the Sept. 10 lowest low (4.301 percent). A preponderance of Fed funds futures (FF) traders think the Fed will cut rates again at the Oct. 31 policy meeting, and perhaps again at the Dec. 11 meeting, implying the entire yield curve will shift downward — to the dollar’s disadvantage.

• Former Fed chief Alan Greenspan, on the talk-show circuit to sell his book, says the probability of recession in the U.S. is 33 to 50 percent. A 50-percent probability is very, very high. George Soros feels the probability of recession as higher than officials see it, without naming names or a percentage figure.

• The dollar hit an all-time low (1.4319) against the euro, and the U.S. dollar index (DXY) hit an alltime low of 77.33 (Figure 1).

• Earlier the same week, the U.S. Treasury reported that U.S. net long-term portfolio investment was an outflow of $69.3 billion — when the U.S. needs about $60 billion inflow per month to “fund” the current account deficit. Short-term flows (bank deposits and fixed-rate securities of 12 months and shorter) were negative, too, at $93.7 billion. The total Treasury International Capital System (TICS) shortfall in August was a jaw-dropping $163 billion. At the same time, U.S. investors bought double the amount of foreign equities in August as in July ($12.8 billion), and switched from being sellers of foreign fixed income in July to big buyers in August ($21.7 billion). The TICS headline number in August was both a record net outflow as well as the first negative figure since August 1998, which was the height of the 1997-1998 emerging market crisis.

• In addition to some limited reserve diversification, sovereign wealth funds are the new fad among governments, and there are no rules for transparency. As far as anyone can tell, the funds will have a preference for non-dollar assets, including the euro and emerging market assets.

• The Group of Seven (G7) met and declined to express concern about the dollar, which is interpreted as a green light to keep selling it. The G7 said exactly what it has said before — that excess volatility is undesirable and that currencies should trade in line with fundamentals.

This is about as bad as it gets, at least in terms of publicity. Even the general public knows about the crashing dollar. Commentators have been talking for more than a month about how to profit from the ongoing dollar decline. E-mail boxes are stuffed with come ons to lure the hobby trader into currencies. A one-way street is an enticing path if you are a newcomer.

But amateurs and newcomers are famously the ones who get their heads handed to them. We need to look a little deeper into cause and effect. After all, some forex traders have been saying for some time the dollar would fall to 1.4500 against the euro, maybe even 1.5000. If conditions were so awful during the extraordinary week of Oct. 15-19, why didn’t the euro hit 1.4500? Instead, the euro closed at 1.4310 on Friday, Oct. 19 — only about 100 points above where it started the month. This doesn’t seem like dollar crisis pricing. And the day after the all-time high (Monday, Oct. 22), the euro spiked down more than 200 points in European trading hours, evidently on profit-taking.

Crisis? What crisis? This is business as usual. The list of factors contributing to the dollar drop can mostly be explained away, without referencing a “crisis.”