"The world’s foreign exchanges were today readying themselves for parity between sterling and the euro"

Another good EconomPic Data post:

"Euro Approaching Parity with Pound Sterling

Guardian (hat tip Credit Writedowns):

The world’s foreign exchanges were today readying themselves for parity between sterling and the euro after further selling sent the pound to within touching distance of a one-for-one exchange rate against the European currency.

The euro has risen by almost a third against the pound in the course of 2008, with an 18% appreciation in December alone. Sterling’s trade-weighted index against a basket of currencies fell to 74.2% of its 2005 value, its lowest since the Bank of England first kept daily records in 1990.

"if they start to view the pound as Europe’s equivalent of an Agency bond …"

Brad Setser on the wild ride of the dollar recently:

"Only a few days ago, so it seems, it took about $1.25 to buy a euro. Now it takes closer to $1.45 (it was more earlier today, but the dollar subsequently rallied). And — as Macro Man notes — the dollar’s move pales relative to the recent slide in the pound. Not so long ago a pound bought 1.5 euros. Now it buys a euro and change. The Anglo-Saxon currencies haven’t had a good two week run.

Both the US and the UK ( 1 ) had housing and finance centric economies. Both have ( 2 ) significant external deficits. And both are ( 3 ) inclined to use monetary and fiscal policy aggressively to combat a downturn.

But with global trade collapsing, the euro’s rise can not be all that comfortable for members of the eurozone. It isn’t clear that any one wants a stronger currency right now ( THIS MEANS THAT THEIR EXPORTS WILL BE MORE EXPENSIVE IN OTHER COUNTRIES, AND THEY DON'T WANT TO LOSE EXPORT BUSINESS DURING AN ECONOMIC DOWNTURN ). Currencies though are relative prices — and can go up or down amid a global contraction. In theory, everyone could ease monetary policy equally without changing the relative value of any currencies ( THIS WOULD KEEP THE DOLLAR HIGHER ). In practice things rarely work out as neatly ( EXACTLY ).

Dr. Krugman, I would assume, hopes that the euro’s rise puts more pressure on Germany to join a coordinated European fiscal stimulus — with good reason. Germany’s export machine relies on global and European demand. That demand is falling (watch Russian imports for example). And if the euro’s rally is sustained, Germany will soon face an additional headwind. So too will the less competitive members of the eurozone. They are in an even more difficult position if Germany doesn’t lead a coordinated European reflation. ( GERMAN EXPORTS WILL BE TOO EXPENSIVE )

Four other thoughts:

1) Until fairly recently, all the European currencies tended to move in tandem against the dollar. That meant their cross-rates were stable. And it meant that the euro wasn’t as strong as it seemed. The euro was strong against the dollar and the yen, but not against the pound, the Swedish krona, the Norwegian krona and similar currencies. Right now the euro is rising against all the smaller European currencies — not just against the dollar.

2) Japan is starting too worry about yen strength, not surprising. Renewed intervention seems like a possibility if the yen continues to rise. That shouldn’t be a surprise. Japan tends to intervene heavily when the interest different between the yen and dollar goes away, reducing private market demand for dollars.

3) China has to be pleased by the euro’s rally. Dollar strength translated into RMB strength — and a rising RMB when Chinese exports were slowing (and likely now falling) made Chinese policy makers uncomfortable. There was even talk of moving to a real basket peg — which would have meant that RMB would depreciate against the dollar when the dollar was strong. But I rather doubt that China now wants to appreciate against the dollar to offset the dollar’s renewed weakness against the euro. Right now China is happy to see the dollar and thus the RMB weaken( THAT WAY THEIR EXPORTS DON'T GET MORE EXPENSIVE FOR US ) …

4) Central banks have been big buyers of the pound over the past few years. Reserves were growing, and the pound’s share was rising. Central banks liked its yield( PAID HIGHER INTEREST ) — and the fact that it an easy alternative to both the dollar and the euro. By my count, central bank inflows often were large enough to cover the UK’s current account deficit. Central banks reserves are shooting up, but if they “rebalance” their portfolios they should be big buyers of pounds now — as they need to hold more pounds to keep the pound’s share of their portfolio up as the pound’s value slides.

I’ll be interested to see if they do so — or if they start to view the pound as Europe’s equivalent of an Agency bond …( AND NOT BUY IT AS TOO RISKY )

Notice the Chinese Contradiction:

1) They don't want the dollar to weaken so that they can export to us

2) That's happening because we're printing money

3) Yet, they tell us not to borrow too much from them, and they don't want to spend too much

Problem: On 3, it has to be one or the other

Either we borrow more and they save more

or

we save more and they spend more

"The dollar doesn’t have to go south if all the economies reflate at the same time.”

I like William Gross, so here's a chance to quote him from Bloomberg:

"By Ye Xie

Dec. 11 (Bloomberg) -- The dollar fell to a six-week low against the euro and yen as the cost of borrowing in the U.S. currency tumbled, signaling less demand for year-end funding.

The greenback also dropped after a report showed the U.S. trade deficit unexpectedly widened in October. The Swiss franc dropped against the euro and yen after the central bank reduced its main interest rate to a four-year low of 0.5 percent.

“Dollar liquidity and funding concerns are starting to fade,” said Shaun Osborne, chief currency strategist in Toronto at TD Securities Inc., a unit of Canada’s second largest bank. “These factors have been important sources of support for the dollar in the past few months.”

The U.S. currency fell 1.7 percent to $1.3243 per euro at 8:40 a.m. in New York, from $1.3023 yesterday. It dropped 1.6 percent to 91.28 yen from 92.76. The euro traded at 120.77 yen, compared with 120.78 yen.

The cost of borrowing in dollars for three months in London fell to the lowest level in more than four years. The London interbank offered rate, or Libor, that banks say they charge each other for such loans slid 0.1 percentage point to 2 percent, the lowest level since September 2004, British Bankers’ Association data showed. That’s still one percentage point above the Fed target, up from an average of 16 basis points in the seven years to August 2007, when the credit freeze began.

“From a fundamental basis, there’s a case for avoiding the dollar,” said Adrian Schmidt, a London-based senior foreign- exchange strategist at the Royal Bank of Scotland Plc, the fourth-biggest currency trader. “For the moment the dollar’s on the back foot.”

How interesting.

"The ICE’s Dollar Index, which tracks the greenback against the euro, the yen, the pound, the Canadian dollar, the Swiss franc and Sweden’s krona, fell 1.2 percent at 84.449, below the 55-moving-day average of 84.5, as traders took advantage of the low liquidity to test how far it may fall, Hardman said. They will drive the dollar to $1.345 per euro this year, he said.

The dollar has gained 11 percent against the euro in 2008 as the credit-market seizure and $980 billion of losses on mortgage-related securities worldwide led investors to repatriate overseas investments to the U.S. and seek funding in the greenback.

The yen gained versus all 178 currencies tracked by Bloomberg this year as the global recession encouraged Japanese investors to bring funds back home and global equities plunged.

Japan’s currency jumped 21 percent versus the dollar, 34 percent against the euro and 66 percent against Brazil’s real as the financial crisis prompted investors to reverse carry trades, in which they purchase higher-yielding assets funded in countries where borrowing costs are lower. Japan’s benchmark rate of 0.3 percent is the lowest among major economies.

The U.S. trade deficit expanded 1.1 percent to $57.2 billion in October from a revised $56.6 billion in September, the Commerce Department said today in Washington. The gap was projected to narrow to $53.5 billion from an initially reported $56.5 billion in September, according to the median forecast in a Bloomberg News survey of 70 economists.

The U.S. budget deficit in November swelled to $164.4 billion, from $98.2 billion in the year-earlier period, as the government used taxpayer money to shore up the financial system by buying stakes in banks, the Treasury Department reported yesterday. Government revenue fell 4.2 percent, while spending soared 24 percent."

Let's see what Gross says:

"The dollar may extend its decline as the U.S. government increases its budget deficit by spending “trillions of dollars” to revive the economy, said Bill Gross, manager of the world’s biggest bond fund at Pacific Investment Management Co. in Newport Beach, California.

“There’s some risk” for the dollar to weaken, Gross said in an interview on Bloomberg Television yesterday. “It is fair to say other economies are doing much the same thing. The dollar doesn’t have to go south if all the economies reflate at the same time.”

Let's hope for "reflation" ( Another term. Yikes. ) , I suppose.

The Risk Averse Are Coming To America

One consequence of deleveraging:

``We expect risk aversion and ongoing deleveraging to be positive for the dollar, particularly against currencies where the central bank has more room to cut, such as the euro,'' wrote currency strategists led by Zurich-based Mansoor Mohi-uddin at UBS AG, in a research note yesterday. "

Okay.

"Nov. 18 (Bloomberg) -- The dollar rose against the euro and the yen on speculation overseas investors are buying more of the safest U.S. assets as the global economy enters a recession.

The greenback approached a two-year high versus a basket of currencies of six trading partners before the Treasury releases data today that will probably show increased investment in the nation's securities. The Australian dollar declined after the country's central bank said it favored lower borrowing costs.

``We've got this pervasive risk aversion, and we are seeing dollar assets as attractive in a world permeated by fear,'' said Adam Carr, senior economist at ICAP Australia Ltd. in Sydney. ``I'm bullish on the U.S. dollar.''

They're coming to America:

"Overseas investors bought a net $27.2 billion of U.S. assets in September, from $14 billion in August, according to a Bloomberg News survey of economists. The Treasury will release the report at 9 a.m. today in Washington.

Dollar Index

The Treasury received investor bids for four-week bills totaling more than triple the $34 billion that were sold at its Nov. 12 auction. The four-week bills were sold at the lowest rate since they were first auctioned in 2001."

So will exports go down? And will our debt continue to be funded?

Here's an older post making a similar point:

"Saturday, October 25, 2008

" Investors around the world fled stocks and rushed to the relative safety of the U.S. dollar"

The effects of the crisis are spreading. See this post in the Washington Post:

"Gloom about economic growth translated to low expectations for oil consumption. The Organization of the Petroleum Exporting Countries yesterday announced a cut of 1.5 million barrels a day in output -- a move that still failed to arrest the slide in crude prices. Meanwhile, copper prices fell to a three-year low.

Investors around the world fled stocks and rushed to the relative safety of the U.S. dollar by pouring money into 30-year Treasury bonds, a refuge in times of uncertainty. That drove down the value of foreign currencies, from the ruble to the rupee and the zloty to the peso, forcing central banks to spend billions of dollars to prevent even further deterioration. The turmoil in currency markets threatened to reorder trade relations and complicate recovery efforts."

Here's my comment:

DonthelibertarianDemocrat wrote:

"Investors around the world fled stocks and rushed to the relative safety of the U.S. dollar by pouring money into 30-year Treasury bonds, a refuge in times of uncertainty. That drove down the value of foreign currencies, from the ruble to the rupee and the zloty to the peso, forcing central banks to spend billions of dollars to prevent even further deterioration. The turmoil in currency markets threatened to reorder trade relations and complicate recovery efforts."

Doesn't this point out that the U.S. is still the key to worldwide investment?

"Tobias Levkovich, a Citigroup equity strategist, said lower gasoline prices would act like a more than $150 billion stimulus for U.S. consumers."

This would seem to favor a government stimulus directed at infrastructure, say, since the drop in the price of oil has, in effect, given a tax break or stimulus to the consumer.

10/25/2008 11:06:42 AM

"To add insult to injury the US government is now paying 2-3 percentage points less on its short term debt "

Weren't we advised not to compete against each other in this crisis. From Vox, Daniel Gros and Stefano Micossi:

"The plunging euro

Why is the euro plunging against the dollar and the yen? Why are European banks coming under renewed pressure? Should the emerging financial and foreign exchange crisis of countries gravitating around the euro lead to new EU policy instruments?

The euro is plunging against the dollar because investors, in their scramble for safety and liquidity, are flocking to US and, also to some extent, Japanese government bonds which are considered safer and more liquid than other government-backed paper available in the market – including public debt instruments issued by European governments. In other words, the constellation of separate markets for sovereign debt paper of unequal quality issued by European governments cannot compete with the US market for the huge global financial flows in search of a safe harbour. Until the EU develops a unified market for bonds denominated in euro and backed jointly by EU member states – or, better, by euro-area member states – its claim for the status of reserve currency for the euro will not be met. As a result, capital is not coming to Europe, where it is badly needed to shore up its shaken financial system; moreover, the US will continue to dictate the agenda in international monetary affairs, even now, after the colossal damage inflicted on the world by their misguided macro and regulatory policies. To add insult to injury the US government is now paying 2-3 percentage points less on its short term debt than even the most virtuous EU member states."

Situation:

1) In this crisis, investors are investing in the U.S. and Japan

Problem:

1) Not Europe

2) America caused crisis, and we're getting screwed

Solution:

1) European bonds in euros backed jointly

"The overall message from financial markets is that investors everywhere have developed a strong preference for public debt. In the US and Japan, public debt carries no risk because if needed the government could always force the (national) central bank to print the money needed to meet its obligations. But this is not the case in Europe since no European government can force the ECB to print money. For international investors there is thus no euro area government bond in which they could invest to diversify their risk away from the dollar.

We thus have at the same time strong demand for ‘European’ bonds and a need for massive government capital infusions to prevent the crisis from getting worse in the banking sector and the European periphery. This is why the EU should set up a massive European Financial Stability Fund (EFSF). The fund will probably have to be at least on the scale of the US Troubled Assets Relief Programme (TARP), say €500–700 billion. It would issue bonds on the international market with the explicit guarantee of member states. As the rationale for the EFSF is crisis management, its operations should be wound down after a pre-determined period (5 years?). For global investors EFSF bonds would be practically riskless having the backing of all member states."

Situation

1) Investors love public debt in countries with central banks that can print money

Problem

1) Europe doesn't

Solution

1) European bonds backed by national banks jointly ( By the way, I love the phrase "practically riskless)

"The resources available to the EFSF would be used mainly for bank recapitalisation, especially for those banks which rather ‘gamble for resurrection’ than accept the presence of heavy handed interference of national governments. Moreover, the EFSF could also beef up the funding of existing EU instruments for balance of payments assistance to the European neighbourhood. But a key consideration in setting up such an emergency fund should not be the problems that are already known. Given the unpredictable nature of this crisis, a key consideration should be for the EU to prepare for the ‘unknown unknowns’ that are certain to arrive sooner rather than later."

Did they really say 'unknown unknowns'?

Anyway:

1) Let's give the money to banks trying to remain private ( with government money)
2) They like TARP

Good luck.