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Now that the
has indicated that that its risk assessment has changed -- less concerned about the risks of a significant contraction in the economy and more concerned about inflation and inflation expectations -- there has been some renewed speculation that the G8 meeting could be the forum where intervention in the currency market is more likely. The goal of such intervention would ostensibly be to prick the bubble in commodities.
The risk of this happening is minimal. First, the G8 meeting is not a proper venue for this, without central bankers at the meeting. Second, the link between commodity prices and the dollar is far from clear. If the goal is, for example, to lower the price of oil, then intervening in the foreign-exchange market seems too indirect and does not have high odds of success.
Look at the euro, which is where the interventionists are suggesting that the operation take place. It has been trading broadly sideways between $1.53 and $1.60, about a 4.5% range, since mid-March. In the past couple of days, the euro has fallen by 2.5%. And oil? Using the July futures contract as our proxy, the price of crude has risen nearly 40% while the euro has been range-bound.
At yesterday's low, the euro moved within about 0.5% of its 100-day moving average. Meanwhile, July crude is trading about 22% above its 200-day moving average.
Better Ways to Lower Oil
There are more direct ways to try to influence the price of oil. For example, after Hurricane Katrina, the International Energy Agency, in cooperation with the E.U., provided oil (about 60 million barrels) and products to the market. Another step that would be more direct than intervention in the foreign-exchange market would be to lower the speed limit for autos and trucks.
What about the grains? The price of foodstuffs has skyrocketed. Surely a strong dollar would reverse this, right? That seems to be largely wishful thinking. As we have argued previously, while there are many factors influencing the price of grains, the decline in the dollar seems marginal.
Look at corn, for example. It has rallied for six consecutive sessions. We all know about ethanol, but that has not changed. The big change is the weather. In the corn-growing region in the Midwest, there has been roughly four times more rain that normal over the past 60 days. This is leading to low rate of crop emergence (74% vs. 92% a year ago and a five-year average of 89%).
Moreover, the U.S. Department of Agriculture cut its estimate of this year's crop by 3.1% from its estimate last month. The crop may be 10% smaller than last year's.
Only 23% of the soybean crop has emerged vs. 64% a year ago. That said, Brazil is reporting that its soybean harvest will be about 2.5% larger than last year's. Brazil's corn crop also looks about 13% larger. The bottom line is that a stronger dollar does not necessarily mean lower energy or food prices.
Risks of Intervention
If policy makers cannot be confident that intervention would achieve the desired impact on commodity prices, should they be concerned about the potential risks of intervention? The risk of intervention is that is not effective in pushing the dollar up. Sovereign wealth funds, for example, were not nearly as big in 2000 the last time the G7 intervened. What if they take advantage of a G7-inspired bounce in the dollar to diversify reserves?
Also, ahead of the U.S. strategic dialogue with China, intervention could send the PRC a confusing message, i.e., we want currencies to be set in a free market, unless we don't like the direction (or speed) the market is moving. Recently, China has been playing a bit of tit-for-tat. In nearly every international forum possible, the U.S. has pressed China to allow its currency to appreciate faster.
Recently China has taken to recommending that the U.S. do more to appreciate the dollar; China contends that weakness in the dollar is a destabilizing force. Intervention now then would not only obfuscate the strategic message being sent to China, it would make it appear as though we are capitulating to its public rhetoric campaign.
George W. Bush is the first U.S. president since at least the breakup of Bretton Woods in the early 1970s not to have authorized intervention. The bar for his approval is obviously high. If Bush has not been persuaded by any of the events or market developments in the nearly eight years to sanction intervention, it requires a stretch of the imagination beyond my capability to see that present circumstance would justify it. This is especially true since an investment banker is the head of the Treasury Department.
Marc Chandler has been covering the global capital markets in one fashion or another for nearly 20 years, working at economic consulting firms and global investment banks. Currently, he is the chief foreign exchange strategist at Brown Brothers Harriman. Recently, Chandler was the chief currency strategist for HSBC Bank USA. He is a prolific writer and speaker and appears regularly on CNBC. In addition to being quoted in the financial press, Chandler is often a guest writer for the Financial Times. He also teaches at New York University, where he is an associate professor in the School of Continuing and Professional Studies. While Chandler cannot provide investment advice or recommendations, he appreciates your feedback;
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