By David Ethridge
Is the Bush Administration still behind the "strong dollar"? Treasury Secretary John Snow continues to give lip service to the long-stated policy -- while at the same time supporting the view that the value of the dollar is best set by market forces, with formal intervention kept to a minimum as a policy tool.
His boss may not be on the same page, though. President Bush says the goal of free trade also means "fair" currency policies from abroad. That's a veiled call for China and other Asian countries to move away from direct pegs or other manipulative practices to keep their currencies weaker than market forces would dictate.
Look for more rhetorical maneuvering in Washington in the months ahead. The ongoing loss of U.S. factory jobs –- which some industry and labor groups attribute in part to exporters like China keeping their currencies artificially depressed vs. the greenback -- has made the dollar/foreign exchange issue more of a political flashpoint for the 2004 Presidential election (see BW Online, 10/3/03, "Is the Job Drain China's Fault?"). Team Bush has already persuaded the Group of Seven industrial powers to back a broad call for more flexible exchange rates to fix the global-trade imbalances -- and to avoid protectionist measures from Congress.
Things are heating up in Congress as well. A bipartisan group of U.S. senators has requested the Treasury Dept. to investigate if China, in particular, is unfairly manipulating its currency for export advantage. Treasury, under Section 3005 of the U.S. Omnibus Trade & Competitiveness Act of 1988, issues an annual review to Congress on international economic and foreign exchange (forex) policies of other countries for this very purpose.
Snow was scheduled to testify on Oct. 16 before the Senate Banking Committee about forex issues, but that has been postponed in order for the Secretary to speak on another pressing topic: reform of government-sponsored enterprises (GSEs) like Freddie Mac (FRE ) and Fannie Mae (FNM ).
The postponement may well delay the release of Treasury's biannual report on forex which was set for Oct. 15 amid speculation that the U.S. government might list China and perhaps other Asian countries (i.e., Japan) as "foreign exchange manipulators." Such a pronouncement could make forex speculators more inclined to sell the dollar vs. the Japanese yen as the main proxy for the Asian bloc, on the view that Japanese monetary authorities may temper their high profile dollar-yen intervention.
Of course, whether the dollar's value is "fair" or "strong" is a relative notion from a policy perspective. As it stands, the greenback remains at a relatively high level vs. other currencies. While the narrow Finex dollar index (which tracks the greenback vs. the currencies of six major U.S. trading partners, though it's heavily weighted toward the euro) has fallen 24% from its 2002 peak, the Federal Reserve's broader trade-weighted index (TWI) has lost less than 11% of its value, compared to a near 50% appreciation from early 1995 to the early 2002 high. Moreover, the dollar's inflation-adjusted broad TWI is down only 8% from a year ago and is still more than 20% higher than its 1995 cycle low -- hardly a major collapse.
With those figures as a backdrop, it appears Treasury is seeking a targeted approach to the related trade and forex issues by trying to focus market attention on the Asian side of the global imbalance, without backing a broad dollar decline. A broad-based fall in the greenback vs. major currencies worldwide could spook the U.S. bond market, driving yields higher and thereby derailing the economic recovery (see BW Online, 9/11/03, "The Risks of Getting Tough with China").
Moreover, the Bush Administration is calling on China to make a gradual shift to a more flexible forex policy, given the country's huge holdings of U.S. Treasury and agency debt. Based on the value of a market-trading instrument known as nondeliverable forwards, the odds favor some relaxation in China's currency peg vs. the U.S. dollar well before the November, 2004, election.
Pressure is clearly building on Bush & Co. to do something about the growing trade gap with the Middle Kingdom. China posted a record $103 billion trade surplus with the U.S. in 2002. So far this year, it has increased 24%, to $65 billion, from the comparable year-ago period. China accounted for 11% of U.S. imports in 2002, up from 3% in 1990. (It's worth noting that many imports from China are goods from other Asian economies that are processed or finished in China before shipping to the U.S.)
China's ascendancy has come at the expense of other exporters in the region. The combined share of exports to the U.S. from Japan, Korea, and Taiwan fell to 17%, from 27%, over the same time. More U.S. companies are also setting up production shops in China as a cheaper export platform.
Given the complex -- and fluid -- mix of political and economic factors at work, financial markets should bear in mind that U.S. dollar policy is not straightforward, despite the official spin. For now, Washington appears to be asking Asia to shoulder the effects of the revaluation of the region's currencies vs. the greenback –- and thereby keep a lid on growing protectionist sentiment -- until U.S. growth in jobs and manufacturing gains a stronger footing.
Ethridge is a senior market strategist for MMS International
Edited by William Andrews