TimesOnline's Anatole Kaletsky: Why the buck will rebound

Why the buck will rebound
Anatole Kaletsky
TimesOnline

The dollar's collapse has all the characteristics of a financial speculation reaching its climax

IN THE past week, the value of the pound has risen to almost $2, the first time that sterling has been anywhere near this level since just before Black Wednesday in September 1992. The euro has been hitting record highs against the dollar almost daily. And everyone from Alan Greenspan, the Chairman of the Federal Reserve Board, to the humblest foreign exchange clerk, seems convinced that the dollar is bound to keep falling.

Does this mean that British businesses and investors should prepare themselves for a pound worth more than $2, a level never breached since 1981? Or is this a once-in-a-lifetime opportunity for British savers to buy dollars at a bargain price?

Economists who want to protect their academic reputations are usually careful to avoid financial predictions. This is especially true of currency movements, which are considered impossible to forecast. Fortunately, journalists do not have reputations to protect and need not be bound by this convention. Thus, the cover story of this week’s Economist magazine has the headline “The Disappearing Dollar”. It bravely predicts that devaluation of the dollar from its present level is “inevitable” and suggests the possibility of a further 30 per cent fall. I take the opposite view. In my opinion, the dollar has now reached a level from which it can only rise, at least against the euro and pound.

Anyone who buys dollars at the present exchange rate may suffer some sleepless nights in the short term, since pure momentum could continue to drive the dollar downwards for another month or two. But looking slightly further ahead (and don’t ask me to be too specific about the timing), it will seem incredible that £1 could be worth $2, just as it is now incredible that companies such as AOL, Amazon and Yahoo! were once worth the hundreds of millions of dollars which investors paid for them in late 1999.

The rise of the pound to almost $2 has been driven entirely by bearish views on the dollar, rather than any particular enthusiasm for sterling. British currency investors should focus on the relationship between the dollar and the euro, rather than the virtues or otherwise of the pound, for once the dollar recovers against the euro, it will also rise against sterling.

In the past few weeks, the dollar’s collapse against the euro has acquired all the characteristics of a financial speculation reaching its climax. That so many experts are so completely convinced of the market’s direction is a classic sign of this. At some point, the policy mistakes and economic imbalances which have driven the dollar downwards will start to be corrected — and that point is probably not far off. The most important of these imbalances is not the US trade deficit or budget deficit, but the weakness of consumption and employment in the eurozone.

A falling currency can be dangerous and unpleasant for a country that is threatened by inflation, but because of intense competition and plenty of surplus labour, America is unlikely to face any serious inflation, at least for the next year or two. Thus the US has no reason to worry about the declining dollar, still less to change its policies.

But America’s trading partners, especially Europe, face a very different prospect. The falling dollar makes American goods cheaper in world markets. It helps to boost US export industries at the expense of industries in Europe, Britain, Japan and the rest of the world. But Europe suffers far more than other exporting economies for two reasons.

First, Europe, and especially Germany, are currently much weaker and more dependent on exports than other economies such as Britain. Secondly, most exporting countries outside Europe link their currencies either formally or unofficially to the dollar. Asian countries are prepared to intervene forcefully in the markets to stop their currencies from getting too uncompetitive — and they have done this to the tune of almost $1,000 billion during the past three years.

The Europeans, by contrast, have followed a dogmatically free-market approach to currency management — bizarrely so, given that the weaknesses of the European economies are mainly due to the rejection of free-market policies in domestic economic management. Thus when the dollar goes down against the euro, so do the Chinese renmimbi, the Korean won and the Japanese yen.

The declining dollar therefore exposes Europe to a devastating pincer movement. At the top end of the market — technology, high-end services, luxury goods and so on — European exporters lose global markets to American and Japanese competitors. At the bottom end, ever cheaper Chinese and Korean exports destroy the low-cost, labour-intensive industries which still provide millions of Europeans with jobs.

If the dollar continues to fall against the euro or even remains near its present level for more than a few weeks, the European Central Bank will face intense pressure to reduce interest rates. If it does so, Europe will have its first serious chance of economic recovery since 1999. And a European recovery would reduce the US trade deficit, underpin the dollar and allow an orderly decline of the euro to a reasonable, competitive rate.

But what if Europe’s central bankers refuse to respond to the dollar’s weakness by easing monetary policy? The market will then do the job for them. This process has already begun. By pushing the euro even higher against the dollar, currency speculators will extinguish all remaining hope of a European economic recovery. As Europe slides into recession, the ECB will be forced to cut interest rates for purely internal reasons. This easing may come too late to revive the European economy, but it will certainly trigger a euro collapse. Either way, the euro will fall, the dollar will recover and, in the process, the pound’s value against the dollar will move back to more reasonable levels. The days of the two-dollar pound are numbered.