Fed's Cheap Dollar Policy Roils Foreigners

by John M. Curtis
(310) 204-8700

Copyright August 7, 2013
All Rights Reserved.                                      

             Rising to a seven-week peak against the dollar, the Bank of Japan faces a real dilemma, watching Japanese automakers and electronic manufacturers losing profit, robbing companies of vital earnings.  When Federal Reserve Board Chairman Ben S. Bernanke signaled June 19 that he’d start easing its controversial $85 billion a month bond-buying program known as QE3 at year’s end, long-term interest rates rose nearly one-percent overnight.  Almost immediately, the U.S. dollar began falling against the euro, yen and pound sterling, anticipating higher bond prices.  “Dollar sentiment hasn’t been the same since last week’s tepid U.S. jobs report, which suggest the Fed would move more patiently to slow a stimulus program that has long been a thorn in the dollar’s side,” said Joe Manimbo, senior market analyst as Western Union Business Solutions in Washington, D.C.

             When the new jobs report hit August 2, it gave Bernanke reason to pause on the possible tapering of QE3.  Buying less collateralized debt obligations or mortgage-backed securities leaves banks with less liquidity, driving interest rates up and making it more difficult for businesses and individuals to get loans.  Expectations that the Fed might pause on fazing out it bond-buying programs temporarily increased the nation’s debt-to-GDP ratio, running today at about 10%.  Frankfurt-based European Central Bank—the home of the euro—suggests about a 3% debt-to-GDP rations form member states, despite many Eurozone countries running at 10% or higher.  Theoretically, the solvency of any currency is based on lower debt-to-GDP ratios, just like publicly traded companies rely on lower price-to-earnings ratios.  If stocks inflate too much relative to earnings the value of share prices drop.

             U.S. exporters, especially high tech companies in Silicon Valley or the auto industry in Detroit, rely heavily on a cheap dollar policy to make products more affordable overseas.  Beranke’s cheap dollar policy has helped make many U.S. companies more competitive in global markets.  Suppressing the greenback also increases tourism, making U.S. travel a bargain.  Slowing the Fed’s bond purchases helps reduce the U.S. debt-to-GDP ratio, theoretically improving the dollar’s value.  When Chicago Fed President Charles Evans signaled that given the economy’s improvements tapering could begin by year’s end, the dollar began to rise.  Central banks in Frankfurt and Tokyo don’t appreciate having their currencies manipulated, especially because it hurts the bottom lines of foreign manufacturers doing business in the United States, driving down profit-margins and earnings.

             Despite the recession in the U.K. and Europe and slowdown in Asia, foreign currencies rose against the U.S. dollar.  Given steady U.S. economic growth, the U.S. currency should stabilize if not gain against foreign currencies, especially the yen because of the more diverse U.S. manufacturing and technology sales.  Considered a safe-haven currency, the yen has capitalized on currency traders betting against the U.S. dollar.  With the Bank of England promising to not raise rates until unemployment drops below 7%, it makes no sense to see the pound sterling rise against the dollar.  Whatever recession the U.S. faced over the last five years, U.S. GDP remains seven times the U.K. and roughly comparable to 28 member-states of the European Union.  Global currency traders still manipulate foreign currencies, making hefty profits by buying some and shorting others.

             Global currency giants like China and Switzerland don’t allow currency exchanges to openly trade currencies.  Set by the government, the Chinese yuan and Swiss franc maintain consistency, no matter what happens with their GDPs or interest rates.  Considered the world’s reserve currency, the dollar is the currency of choice for most commodity trading, especially petroleum.  Unlike the auto industry which passes on lower profits to foreign auto manufacturers, foreign energy suppliers, whether in Canada, Mexico or the Middle East, drive energy prices up.  Foreign petroleum exchanges automatically increase prices when the dollar drops against foreign currencies.  When the U.S. dollar rises against foreign currencies, foreign automakers don’t discount prices and pass savings on to consumers.  They seize the moment to generate bigger profits and better earnings.

             Expectations that the economy will grow on its own with less Fed intervention has already boosted long-term interest rates.  If it becomes clear that the Fed will taper later this year, interest rates will continue to rise, driving the U.S. dollar higher against foreign currencies.  Driving rates higher will hike the dollars’ value but rob banks of the liquidity needed to make loans and stimulate the economy.  Under pressure from Congress, the Fed may taper bond purchase more quickly than originally anticipated.  With the debt-to-GDP ratio going down, the dollar will probably rise against the Yen, euro and pound sterling.  More value to the U.S. dollar could hurt exports currently enjoying competitive prices against all foreign products.  Unless the economy heads south, Bernanker will turn the screws by year’s end.  Higher interest rates should hold the bloated U.S. stock in check and tame inflationary pressures.

John M. Curtis writes politically neutral commentary analyzing spin in national and global news.  He's editor of OnlineColumnist.com.and author of Dodging the Bullet and Operation Charisma.