A fistful of dollars, a bundle of contradictions
Where there’s risk, there’s opportunity. The dollar’s depressed level may itself hold the key to its eventual recovery.
Contradiction No. 1
These two leaders — OPEC’s own little lunatic fringe — are not among the world’s most respected, but the uncomfortable fact remains the dollar is, to a fairly large extent, a hostage to the price of oil. Other countries are equally dependent on imported oil, though, and while Europe may be getting a break because of the Euro’s strength, it’s not a get-outof- jail-free card. Since the end of 2005, the price of oil has risen 56 percent in dollar terms ($61 to $95) while the euro has gained only 24 percent (1.1844 to 1.4631).
since the world is not really decoupled from the U.S., demand should fall elsewhere, too.
Another rate cut means the Fed is honestly afraid of recession. It’s what Mr. Greenspan would do. But this is the Bernanke Fed. Does he have the salt to stand pat, as suggested in the last Fed statement (“the risks are roughly balanced”)? A Fed rate cut in December would be a big blow to Mr. Bernanke’s inflation-fighting credentials.
We can’t have it both ways — denying the existence of rising inflation and pretending rate cuts will not boost it further. A rate cut removes whatever remaining yield advantage the dollar has over the euro — the yield spread between the U.S. 10-year note and the German Bund (the equivalent 10-year German treasury note) has already been pared to a mere 10 basis points from more than 200 basis points only two years ago. The loss of yield advantage is severely dollar-negative and, if the euro-dollar-oil connection is valid, it implies even higher oil prices, which in turn feeds inflation (or the perception of impending inflation), and so on. It becomes a vicious circle, which is why periods of stagflation need an external shock to be broken.
Contradiction No. 2.
“Investments” such as metals and emerging-market equities remain more attractive than dollar-denominated securities, and it will take a crash of titanic proportions to redirect money back to developed markets in general and the U.S. in particular.
Then things calm down for a day or two and risk appetite, which until recently was called “greed,” pokes its head out again. Carry trades are re-established, the yen falls against everything, and traders are free to bash the dollar. On several occasions, sentiment flip-flopped in a single day, or every two or three days. Trading has been horrible for more than three months now. Sometimes it seems as if the only way to make a buck is by sheer luck — by guessing, for example, that the price of oil would take a breather short of $100. The seeming correlation among equity indices, oil, or gold and currencies is confusing and can be explained only by the unifying factor of risk aversion.
Here’s the contradiction: The U.S. has the world’s biggest economy, the most liquid and transparent financial markets, and is the world’s sole military superpower, but to fund its operations it depends utterly on foreigners to buy its private and public debt while at the same time it acquiesces in the devaluation of the currency. As have all of Mr. Bush’s treasury secretaries, current secretary Henry Paulson continues to repeat “let the market decide.”
To be fair, the government can’t meddle in the Fed’s decision-making, and it would discover outright intervention distasteful and contrary to free market principles (as well as making the U.S. look desperate, which generally only makes things worse). But as with inflation and interest rates, you can’t have it both ways. Something’s got to give. You can’t be the world leader and continue running twin deficits that depend on the kindness of strangers — while offering those strangers less of a return than they can get elsewhere.
BY BARBARA ROCKEFELLER