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US dollar delusion
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If one casts a glance at Bloomberg consensus forecasts on exchange rates, it is clear that consensus does not get it or does not want to get it. There is a slow and steady appreciation of the US dollar pencilled in all the way up to 2015. In other words, we all will live happily ever after, despite strong evidence to the contrary over the last four years. The universe gave most of the humanity a one-time serendipitous combination of circumstances in the 1980s and the 1990s. Commodity prices slumped. The Cold War ended. Information technology innovations burst forth and global trade expanded. We were not intelligent enough to accept that we were blessed by a propitious combination of factors. Instead, we attributed the good times to our good judgement and skills. Phantom explanations, but the hubris was real.
Yet, at the end of it all, we have a stock market bubble that burst in 2000, a global housing bubble that burst in 2008 and a credit boom that has burst in some places and not yet in some other places. The private sector is deleveraging and the public sector compensated for it, but in the wrong places. The jobless remain jobless, but banking sector profits and employee compensation have been restored for the most part. Now, the public sector has no more money to spend on providing stimulus to the broader economy, instead of mostly showering its largesse on the banking sector alone.
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This is the backdrop for predicting that all global currencies would weaken against the US dollar in the years ahead. This is poppycock. Some might be fit candidates given their current overvaluation. Commodity currencies fit the bill. Most of the good news is in the price for them. Bad news is yet to be recognized, let alone priced in. The Australian dollar is a fit case. It peaked against the US dollar earlier in the year and has since slowly been winding its way down. Australian interest rate expectations have also given way to rate cuts from rate hikes. Financial market contracts anticipated Australia to hike rates by 50 basis points six months ago. Now, they expect the Reserve Bank of Australia to cut rates by a whopping 150 basis points in the next 12 months. That might be excessive, but financial markets have got the direction of Australian policy rate right, in our view.
Year-to-date, the Australian dollar is up 2.4% versus the US dollar whereas the Swiss franc is up 17.8%. Hence, it is no surprise that the Australian dollar has weakened against the Swiss franc this year. In the light of escalating uncertainties over the strength of the domestic economic cycle in Australia and the growth momentum in China, it is no surprise that the Australian dollar is not a sought-after currency any more. We should expect this trend to continue.
Financial markets underestimate the dependence of Australia on exports to China. Fully one-fourth of all Australian exports go to China. With China’s economic model having already faced one shock in 2008, it’s about to face another one in 2012 and the government does not have the same firepower to come to the rescue as it did in 2008, especially when it is still counting the costs of the rescue it mounted three years ago.
Consequently, the Australian dollar might hold its own against the beleaguered US dollar, but it should continue to lose ground against currencies perceived to be safe havens in the light of the ongoing and likely unfolding global economic and political turmoil.
In fact, China is going to come under intense scrutiny both within and without for its ongoing accumulation of the euro. This strategy is aiding no one but Germany. The euro zone, excluding Germany, has a trade deficit with the rest of the world. It needs a weaker currency. The collapse in Asian currencies aided the regional recovery after the crisis in 1997-98. China’s purchase of the euro denies such an opportunity for many European nations. Thus, China is making the possibility of the monetary union in Europe breaking up into two come a lot closer to reality.
For the euro zone to survive in its present form, the euro should be a lot weaker, especially against Asian currencies. Accumulating euros prevents both the euro zone and the US from benefiting from weaker exchange rates. The weakness of the dollar against a demand-deficient euro zone is not going to help American exports either. Anger against Chinese tactics could boil over in 2012.
Hence, to expect the US dollar to strengthen against global currencies from 2012 onwards without first weakening substantially against Asian currencies is to expect a miraculous recovery in domestic demand in the US and “business as usual" for Asian exporting nations. If nothing else, what we are going to discover in 2012 is that it is going to be anything but “business as usual".
V. Anantha Nageswaran is an independent macroeconomic and investment strategy consultant based in Singapore. Your comments are welcome at baretalk@livemint.com
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