Dollar decline draws international protest


By Katie Martin
The Wall Street Journal
Tuesday, October 21, 2009

LONDON -- This could end up being viewed as the week when dollar weakness became too much for the rest of the world to bear, setting the scene for tense encounters at the upcoming meeting of finance ministers from the world's 20 largest economies.

Brazil has now imposed a tax on some foreign-exchange inflows. The Bank of Canada has cranked up its negative tone on the strength of the Canadian dollar. And a whole slew of European officials have practically begged the U.S. to step in and boost the buck.

This chorus of pain marks a rise in international pressure on the U.S. to live up to its oft-quoted "strong-dollar policy," after central banks in South Korea, Taiwan, the Philippines, Thailand, Indonesia and Hong Kong all stepped in to weaken their currencies against the greenback earlier this month.

Now, the G20 meeting scheduled for Nov. 6-7 in Scotland will offer a perfect forum for such concerns over dollar weakness to be aired.

"I think there will be fireworks at the G20," said Stephen Jen, a well-respected currencies investor at hedge fund BlueGold Capital Management in London. "The G20 has such diverse membership" that disagreement over how to handle the dollar's decline is very likely, he added.

When measured against a basket of currencies from the U.S.'s trading partners, the dollar is now only around 7% above its lowest point since 1971. The greenback has recently hit some notable lows against a range of currencies, with the euro briefly nudging $1.50 Wednesday.

"Some sort of crisis is looking inevitable," said Neil Mellor, a currencies analyst at the Bank of New York Mellon in London. "You can't continue down this road without something giving way, and it's clear that the U.S. is not going to do anything to put meat on the bones of its strong-dollar policy."

The strain is certainly starting to show. Most countries would greatly prefer to see their currencies weaken, because it makes their exports appear cheaper -- a boost when economies are edging out of the global downturn. Instead, many currencies are climbing, not necessarily because of domestic factors, but because the dollar is sliding as newly optimistic investors pull funds out of the greenback, to which they had turned as a safe haven in deeply troubled times.

Brazil's government took action Tuesday, slapping a 2% tax on foreign purchases of bonds and shares in a direct effort to rein in the Brazilian real, which has risen by nearly 31% against the dollar since March.

The new tax rule sent some investors scurrying for the exits and immediately shoved the dollar 3.75% higher against the real in just one day -- a very substantial single-day move in the currency markets.

Currencies watchers are divided about the likely long-term impact of Brazil's move. Some think that with bumper returns still lying ahead in Brazilian assets, many investors will stick with the country, pushing the currency still higher. The Institute of International Finance has estimated that capital flows into emerging markets will almost double from 2009 to 2010.

David Lubin, an emerging-markets economist at Citigroup in London, said Wednesday that he sees little chance of countries in Central and Eastern Europe adopting similar measures, although he cautioned that investors should "never say never."

But skeptics, fearing a potential dollar rout, aren't so sure. "I take the move as a real statement of intent. This could be the thin end of the wedge. There's a crunch coming, and the only route is the Brazilian route -- I think we will see more moves like this," said Mr. Mellor at The Bank of New York Mellon.

Some authorities around the world are more sanguine about dollar weakness, with the Reserve Bank of New Zealand Governor Alan Bollard stating this week that the strength of the New Zealand dollar was no impediment to raising interest rates.

However, Brazil is not alone. Canada's central bank warned Tuesday that persistent strength and volatility in the Canadian dollar could "more than fully offset" other encouraging developments seen in the Canadian economy since July.

The market read this as an indication that intervention to weaken the Canadian dollar could be close to hand, prompting traders to push the U.S. dollar nearly 2% higher against its neighboring currency.

Finally, European officials were particularly forthright this week. French Finance Minister Christine Lagarde said Tuesday that "we want a strong dollar; we need a strong dollar." A senior advisor to French President Nicolas Sarkozy also said that "the euro at $1.50 is a disaster for the European economy and industry." Currency traders, however, decided to ignore these words.

That's because few see a real prospect for a successful unilateral program of intervention in the euro zone. Particularly in the case of this heavily traded currency pair, U.S. involvement in a joint effort to sell euros is seen as crucial, because such large sums would be needed to push the rate around. Intervention programs involving just one country are rarely successful.

For its part, the U.S., publicly favors a strong-dollar policy, mindful that the world's largest economy relies heavily on the goodwill of foreign investors buying its dollar-denominated bonds. However, U.S. Treasury Secretary Timothy Geithner appeared to soften this stance last month, when he indicated that a U.S. transition towards a heavier reliance on exports would be "healthy" and "necessary." Naturally, a weaker dollar would help in that process.

In the end, most experts agree that unless the dollar's decline becomes much more rapid, or unless it provokes a rush away from U.S. government bonds -- both unlikely prospects at this point -- then the U.S. authorities will continue to stand by and let the buck fall.

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