The financial markets have seen a set of stunning reversals over the past few weeks — the US dollar has soared against other major currencies and oil prices have dropped like a stone.
Illustration: Jayachandran / Mint
This is not how the script was supposed to have read. The American currency had been battered ever since the credit crisis reached a tipping point in the world’s largest economy. The deep cuts in US interest rates made dollar assets even less attractive to foreign investors. There was a lot of talk about how the Arabs and the Chinese would start moving their billions out of the dollar into the euro.
But the dollar is now trading at close to six-month highs against major currencies such as the euro, yen and Swiss franc. The underlying fundamental reason is that the US economy has steered clear of recession till now — quite unexpectedly. However, Japan’s economy contracted 0.6% in the second quarter, and major European economies such as Germany, the UK, France and Italy are in similar trouble.
The US economy has been able to grow in the midst of these global problems because of two main reasons. One, US exports have risen 22% over the past 12 months because of a weak dollar. Two, the US government mailed cheques to its citizens as part of a fiscal stimulus package; the money in the mailbox has been spent. These two factors have created the demand needed to expand output. And this relative strength of the US economy has sent investors rushing to the dollar.
The question worth asking is whether the US can maintain its export and domestic consumption growth. Don’t bet on it. Both the slowdown in the rest of the world and the recent jump in the dollar will harm US export growth. Domestic demand will no longer be propped up by a one-time fiscal stimulus. Falling housing prices could curb it further.
There is no doubt that the US economy has been far more resilient than this newspaper had expected. But the problems there have not gone away, either in the financial sector or the overall economy.
Indian firms were lulled by the spectacular rise of the rupee in 2007 to take derivative bets that have now backfired. Some took bets where the underlying exposure was to the dollar-franc exchange rate. Chief financial officers should be more careful taking one-way bets this time around. Neither the US economy nor the dollar is out of the woods, yet.
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