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Talking Down the Dollar

The G7 statement that brought the dollar down suits the White House, but danger might outweigh opportunity.

Friday's creeping

concerns about the dollar crawled up and bit financial markets on the backside Monday. Pronounced weakness in the greenback spread to U.S. Treasuries and equities, fulfilling for at least one session what hardcore bears have long prophesized.

Following the Group of Seven's weekend statement about the desirability of "more flexibility in exchange rates," the dollar suffered its biggest drop vs. the yen in over a year. After trading as low as 111.40 yen overnight, the dollar was at 112.18 yen late Monday in New York, its lowest level since December 2000 and down 1.6% from Friday.

The yen's surge vs. the greenback pulled other currencies higher, noted Lara Rhame, economist at Brown Brothers Harriman. "Everything else pretty much traded as an offshoot of the yen." The euro rose to $1.1474 vs. $1.1361 Friday, while the dollar index shed 1.1%.

In a broader sense, global financial markets traded as an offshoot of currencies, with overseas bourses, U.S. stocks and Treasuries tumbling in concert with the dollar. Meanwhile, gold rallied 1.4% to $388.30 per ounce, its highest close since May 1996.

After Japan's Nikkei fell 4.2% overnight, the

Dow Jones Industrial Average

fell 1.1% to 9535.41, the

S&P 500

shed 1.3% to 1022.79 and the

Nasdaq Composite

lost 1.6% to 1874.47.

Volume was decent at 1.2 billion shares on the

Big Board

and 1.6 billion in Nasdaq trading while breadth greatly favored decliners in both venues. Still, in the absence of major economic data or corporate news, some claimed the dollar's decline was an excuse for selling likely to occur anyway after recent gains.

"After option expiration ended on Friday, there is now no longer any near-term buying pressure that will come to bear on the market until the end of the month when the third quarter ends," Scott Bleier, founder of wrote Monday morning. "Thus, the 'gaming' of the market -- pressure to get the shorts to cover and

others to buy the dips at seemingly any cost -- may reverse itself this week."

In a change from recent trends, Treasuries traded in concert with shares. The price of the benchmark 10-year note fell 20/32 to 100 2/32, its yield rising to 4.24%.

Law of Unintended Consequence

The G7 statement was made at the behest of Bush administration officials, led by Treasury Secretary John Snow. It was widely viewed as a jab against Japan, which until recently had been actively intervening to weaken the yen, and China, which maintains a fixed rate for the yuan. The White House believes those (and other) Asian nations' currency policies have kept the dollar's value artificially high, putting U.S. manufacturers at a competitive disadvantage.

Given the torrent of

job losses in the manufacturing sector, the White House's political motives for encouraging the G7 directive are obvious. (In addition, the Bush administration has a fundamental belief in free markets, one reason it had such a

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tough time inheriting the so-called strong-dollar policy, which is now pretty much dead.)

"They're so concerned about job losses that they want to be perceived as leaving no stone unturned in an effort to get manufacturing in better shape," said Greg Valliere, managing director of Charles Schwab's Washington research group. "They're haunted by the mistakes of Bush One, who was rightly or wrongly portrayed as being disengaged on the economy."

But Valliere doubted currency movements will result in a "significant turnaround" in manufacturing jobs by the November 2004 election and further argued the economy's recent strength negates the need for currency-related action. "Sometimes the smartest thing to do is nothing," he said. "The economy is turning and you're going to get job creation. Why monkey with currencies and get everyone agitated? They're playing with fire on this."

Assuming it's not their intent to roil U.S. stock and bond markets, the Bush administration got singed Monday.

Persistent dollar weakness has long been the linchpin of most bearish scenarios. Naysayers contend the dollar must ultimately weaken because of the

Federal Reserve's

aggressive monetary policy and the U.S.' rising federal budget and current-account deficits. A weaker dollar will undermine the desire of foreigners to own dollar-denominated assets, argue the skeptics, who are undaunted by recent strength in equities and/or second-quarter data showing continued strong inflows from foreigners. (The net value of U.S. assets acquired by foreigners, less foreign assets bought by U.S. residents, rose to $148.6 billion last quarter vs. $140.8 billion in the first quarter.)

Foreigners hold 36% of Treasuries outstanding and should their desire to own or buy more U.S. government securities wane, the U.S. government would be forced to raise rates to attract buyers, with the corresponding negative economic consequences.

To reiterate, the bears have "cried wolf" on the

dollar doomsday scenario countless times previously and one day does not a market make. Furthermore, Schwab's Valliere declared "this is not like the

September 1985 Plaza Accords

when officials overtly tried to get the dollar down."

Still, the G7 statement might turn out to be the trigger of a long-anticipated dollar rout.

"The problem is, how do you prevent markets prone to mania from using

the G7 statement as an excuse to absolutely bury the currency, which is easy to do when you're running a current account deficit nearly 6% of GDP," wondered David Gilmore, partner of Essex, Conn.-based Foreign Exchange Analytics and a


Gilmore recommends clients short the dollar, particularly vs. Asian currencies that have lagged gains vs. the dollar compared with their European counterparts, thanks largely to the Bank of Japan's unprecedented intervention. Foreign Exchange Analytics estimate the Japanese central bank has spent $100 billion year-to-date to weaken the yen, or roughly two times the Treasury Department's entire exchange-rate stabilization fund.

Japan "hasn't pulled the plug" on intervention, Gilmore said, and Japan's March 31 fiscal year-end provides an incentive for them to keep the yen's strength contained. But they'll be less aggressive about intervention going forward or risk riling both the G7 and Treasury Department. The dollar falling to 100 yen is "not wildly pessimistic," he concluded. "The dilemma is when you have a record current-account deficit and your implicit policy is one of orderly decline in the dollar; it's a high-wire act to keep it from becoming disorderly."

Aaron L. Task writes daily for In keeping with TSC's editorial policy, he doesn't own or short individual stocks, although he owns stock in He also doesn't invest in hedge funds or other private investment partnerships. He invites you to send your feedback to

Aaron L. Task.