My first book, Making Sense of the Dollar, was published by Bloomberg Press ten years ago this week. It was named a Bronze medal winner by Independent Publishers. It sought to counter the declinists of the period who, understandably, if even mistakenly, thought the dollar was on an exorable path that had been carved by sterling as it lost numeraire status a century earlier. In 2008, as the book was being written, the euro reached a record high near .60, and sterling was still trading around .00 after peaking in 2007 closer to .12. The Dollar Index tested 70.00 in Q2 08, a record low. Rather than mark the demise of the dollar, the book anticipated a new dollar bull cycle. It was a difficult call then. The manuscript was being written as Lehman failed and the Great
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It may be too early to conclude that the shift toward economic nationalism from international liberalism is more than an aberration. The Democrats seem to support many of the foreign policy goals of the Trump Administration. These include a more direct confrontation of China, denying Iran nuclear capability, getting North Korea to give up its nuclear weapons, regime change in Venezuela, getting NATO members to make good on their commitments, and opposition to the Nord Stream II pipeline that sends Russian gas to directly to Germany. To the extent they disagree, it is over tactics. The Democrats continue to embrace international liberalism, and it is not clear the extent that Trump has made over the Republican Party. The old Lodge-wing (which opposed the League of Nations after WWI) may not have as firm of a grip as it may appear. Next year's election will clarify the situation.
Trump has tried talking the dollar down with little perceptible impact. His administration has seriously discussed intervention in the foreign exchange market. Although many observers think that with the dollar rising above CNY7.0 and not weakening much in the face the Fed's 25 bp rate cut, the risk of intervention is increasing, we suspect the practical issues have not changed, and this strongly argues against such action.
We are not concerned about the limited amount of dollars in the Exchange Stabilization Fund that the Treasury Department can sell. The US modus operandi in intervention has never been trying to overwhelm the market with size. That is something the BOJ has tried to do, with a bout of intervention several years ago, estimated to be about $100 bln in one day. Instead, the US typically relies on finesse and, and like US troops abroad, are more about a signal and tripwire than brute force. We suspect a US operation to sell dollars would have an immediate impact.
The issue is not about selling but buying. With China having been cited as a currency manipulator, the yuan would be the logical candidate, but the currency is not freely convertible, and the US would loathe buying Chinese government bonds, which are used to finance the Belt Road Initiative and the People's Liberation Army. The IMF denies the US charges, and this underscores the aggressiveness of such US action.
We could be wrong, and US intervention would be unsuccessful in weakening the dollar, and unilateral intervention does not have an inspiring track record. This would be embarrassing and erode US credibility in such matters. If it is successful, what stops another country, say China, from using the pullback in the dollar (and likely rise in US yields) to repurchase Treasuries? The US Treasury figures suggest China has sold about $13 bln of Treasuries in the first five months of the year and liquidating about $61 bln last year.
Some suggest the US could buy the euro or yen, but this would be sending confusing signals and needlessly antagonize Europe and Japan. Despite negative interest rates and a still aggressive asset purchase program that includes corporate bonds and equity ETFs, the yen has strengthened nearly 4.3% against the dollar. It is the strongest major currency this year. The dollar is testing JPY105 having had pushed above JPY109 for the first time in two months at the start of August. The strength of the yen will likely add to the disinflationary forces and act as a headwind on growth in H2, just as the government prepares to raise the sales tax (from 8% to 10% in October). Buying the euro and/or yen would force the US to accept negative yields, meaning that it would pay Europe or Japan to take US savings.
This week also marks the 48 anniversary of the end of Bretton Woods. For many years, there has been romanticism about that gold-dollar regime. There has been an almost constant if low-decibel, intellectual fascination with a possible Bretton Woods II. Ten years ago, it did not seem likely, and it is less so today. Bretton Woods was a classic example of hegemonic stability theory. One country, namely the US, had the bulk of the world's gold and military power, having used two atom bombs on Japan, It had the will and ability to set the rules of the international monetary order, over objections by Keynes, who, in effect, negotiated on behalf of the debtors. It has neither the power nor will today. Several countries, including China and Russia, continue to accumulate gold and China has established numerous swap lines. At current prices, gold cannot absorb serious diversification of the roughly $6.7 trillion Treasury holdings by foreign central banks. China's swap lines can be important tactically, and recently Turkey, but this is triage and not a systemic alternative.
While the big dollar rally anticipated by Making Sense of the Dollar is maybe over, the current system in which the greenback remains numeraire remains intact. The strong dollar policy announced by Rubin in 1995 survived a bout of dollar selling intervention by him (against the yen) and his successor (against the euro) and a third bout against the yen (after the earthquake and tsunami in 2011). It survived one administration that tried to ignore, with a vice president claiming a strong dollar was one that was difficult to counterfeit. Whether the greenback's role survives another decade is not clear. We suspect it will survive but diminished. Stay tuned.