Currency War?
Nov 15, 2010
Posted by Jody Eisenman | Filed under Uncategorized
It’s been a tough November for President Obama. First, his party got annihilated in the election. Then, he flew overseas to the G20 summit in Seoul, where his trade ideas met with solid resistance. From South Korea and China. The United States currently has a $227 billion trade deficit with China. As such, it would be in the best interests of our country if the dollar weakened, as it would make our goods cheaper to foreign buyers. When you consider the ongoing financial crisis, the U S is desperately trying to stimulate the economy. That’s was the thought behind QE2, and an injection of another $600 billion into the purchase of longer term treasuries. Unfortunately, investors reacted negatively thus far, with stocks, bonds and commodities all getting hit. Gold dropped 5%. Crude Oil dropped 3%. For the week, the Dow dropped over 250 points. Even treasuries dropped, as the ten year note yield jumped from 2.54 to 2.75%. This is most curious, as the Fed buying was supposed to make bonds more expensive, thus lowering yields. This is not a great start for QE2.
Meanwhile, the other producing nations of the world are viewing the U S moves with alarm. When you try to lower your currency in order to protect domestic industries from foreign competition, it’s called protectionism. This can also be accomplished but putting tariffs (meaning additional taxes) on foreign imports in order to make them more expensive. Unfortunately, this may cause other countries to simply respond in kind. This is one of the reasons for Obamas’ failure at the summit; every time you make U S goods cheaper, you are hurting foreign goods. The U S dollar index, which had dropped from 88 in June to 76 last week, has started back up, and closed Friday at 78.14. Clearly, other nations such as China are doing their best to drop their currencies vis a vis the dollar as well. As such, we have the makings of a potential currency war. Where this winds up is anyone’s guess, but this has not been an auspicious week for the United States. In addition, there is another currency related issue. The U S is, of course, a debtor nation. We exist upon the willingness of investors to purchase our debt. Many of these investors are foreign nations, with the two largest being China and Japan. With rates still low, and our currency losing value, how long will these nations continue to be willing to purchase treasuries. Remember, if the dollar drops versus the Yen and Yuan (as has happened for the last five months), how long will these nations continue to purchase treasuries? If they balk, the U S may be forced to offer higher rates in order to entice buyers. Unfortunately, this is exactly the opposite of what the Fed is trying to achieve.
