Whatever Happened to the Strong Dollar? (Markets)

Article excerpt

The leader of the pack has become the weakest of the pack in the currency world as capital flows seek better investment opportunities elsewhere. Will that trend continue or have concerns about war and a weak U.S. economy been overdone?

When the currency outlook article was written a year ago, the United States was still reeling from the shock of the terrorist attacks on Sept. 11, 2001, and a weakening economy. Most of the world was behind U.S.-led efforts to find the bad guys in Afghanistan and eliminate Osama bin Laden and al Qaeda.

Despite the pressures against it, the U.S. dollar remained the strongest currency, not so much because it was supported by fundamental factors but because other major currencies had their own problems and were even weaker. In fact, the U.S. dollar's position seemed to be firm enough that the article carried the title, "U.S. Dollar: The Winner and Still World Champion" (April 2002).

For those pointing to headlines like that as the kiss of death for a market move, here is a case in point. A year later, much of the world seems to regard the United States as the bad guy as it and some supporting nations try to change the regime in Iraq, an action blamed for everything from economic weakness to a sour stock market to high energy prices to a weak dollar. Confidence in anything U.S. seems to be waning.

TURNABOUT IS FAIR PLAY

Whatever the cause, the picture for the U.S. dollar has turned completely around from a year ago as the euro and Swiss franc have appreciated about 25% vs. the dollar (see "A year later..."). Almost every currency analyst seems to think that trend will persist. For example, only two of 37 forecasters in a National Association for Business Economics survey expect the dollar to strengthen this year. The longer-term charts provide some support for the view that other major currencies will rise at the expense of the U.S. dollar (see "Tech Talk," page 30).

It isn't that economic conditions are so much better outside the United States. In Europe economic growth is stagnating and unemployment is rising, but the euro has surged nevertheless. Even the Japanese yen has advanced significantly against the U.S. dollar. A year ago, analysts expected the yen to fade after the end of repatriation flows on March 31, the end of the Japanese fiscal year when Japanese companies want their books to look the best. Now the market is at that time of the year again, but analysts are more likely to be bullish the yen even though the fundamental economic problems remain.

So what has everybody got against the dollar? "Flight to quality" sums up' the situation, in part because of geopolitical issues and in part because of better investment opportunities elsewhere since the stock market bubble burst in 2000 and the U.S. economy began teetering on the brink of recession.

While President Bush was fiddling, the dollar was burning. As the focus of the war on terrorism shifted to Saddam Hussein and Iraq and a long, drawn-out military buildup, world support for the U.S. cause evaporated. U.S. companies and consumers hesitated to do anything, wanting to see first how a war, regarded as increasingly inevitable, might affect the markets and the economy. The agony of waiting 7 for months through weapons inspections, assorted resolutions and ultimatums, threatened terrorist strikes and other actions related to a potential shooting war took its toll as the U.S. economy weakened further and consumer sentiment declined.

POINT OF NO RETURN

The situation did not inspire confidence in investors to put money into the U.S. stock market, and they couldn't do much better in fixed-income investments with U.S. interest rates at 40-year lows following a dozen rate cuts by the Federal Reserve over the last two years.

"If global investors need to park funds, they can get better returns elsewhere. If the funds go elsewhere, the dollar will depreciate," Paul Kasriel, director of economic research at Northern Trust Bank in Chicago, sums up the situation. …