Expert View: A lot of sound and fury on the dollar, signifying nothing

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The Independent Online

Just as last month everyone was an expert on Chinese oil demand and American oil inventories, now they all talk earnestly of the US current account deficit and the "inevitable fall" of the dollar.

Just as last month everyone was an expert on Chinese oil demand and American oil inventories, now they all talk earnestly of the US current account deficit and the "inevitable fall" of the dollar.

But for all the headlines and dramatic predictions, it is worth mentioning that the trade-weighted dollar index is down from 86.9 on 1 January this year to 81.9 this weekend - a fall of just under 7 per cent. By contrast, crude oil, despite falling sharply over the past month, is still up 65 per cent this year while Copper is up 35 per cent. Gold, the other story grabbing the headlines, is actually only around 12 per cent higher, yet silver is up 28 per cent.

So much for the noise. More important is that the "fundamentals" being used to explain the dollar's weakness are obscuring the real story. Many talk about a dollar correction similar to that seen in 1985, but unlike then, it is not wildly expensive - against continental Europe and the UK, it is already cheap.

Also, the current account deficit is being presented as a US problem that needs to be solved by a dramatically weaker dollar. Not only is this the wrong solution, it is also the wrong problem.

The issue is not too much US consumption, it is too little elsewhere. In Japan, the UK and continental Europe, demographics, low bond yields, pension black holes, rigid labour markets and a dependency on exports have left consumers depressed. The current account deficit is simply telling us about relative economic growth between the US and the rest.

The market solution is likely to be the rise of the Asian consumer. Equity investors have already acknowledged the fundamentals, buying into the Asian growth story and selling out of companies that are exposed to European consumers. By contrast, the sado-monetarist tendency would address the issue of the US growing twice as fast as Europe by halving US growth. No wonder they call economics the dismal science.

But if the US is relatively robust, why on earth is anyone buying the euro? Two key players are involved, both of whom may stop quite soon. On the one hand, there is an interesting and quite compelling argument that the real distortion going on in currency markets comes from the Japanese buying euros rather than dollars to protect their exports. We know the Japanese were intervening against the dollar earlier in the year - in effect selling yen and buying dollars to keep the value of the yen competitive. The suggestion now, though, is that what they have actually been doing is selling yen to buy euros, for Japan's real rival for the American consumer dollar is not China but Europe.

The other buyer appears to be the US investor. Mutual fund flows suggest almost three-quarters of funds bought over the past four weeks have been invested in international equities. But they are not buying into Europe per se; they appear to be buying into the international growth story through equities that will benefit from the Asian story but are denominated in euros (or sterling, or krona). We saw something similar last year and it faded.

In the long run, fortunately, markets follow fundamentals, not "noise traders" or central bank officials. So over the next six to 12 months I would broadly expect the dollar to go down against Asian currencies but up against the euro and sterling.

In the shorter term? To quote the chief of the US Federal Reserve, Alan Greenspan: "The inability to anticipate changes in supply and demand for a currency is at the root of the statistically robust finding that forecasting exchange rates has a success rate no better than that of forecasting a coin toss."

Mark Tinker is a director of Execution Stockbrokers. Mark.Tinker@executionlimited.com

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