Monday, January 28, 2008
Is the dollar turning into the yen?
Financial markets are dangerous territory for me to blog, since I know less about them than any of my co-bloggers. That said, the theory of this morning's "Ahead of the Tape" column in today's Wall Street Journal strikes me as unlikely to be true over any sustained period:
The U.S. financial crisis is starting to look eerily like Japan's: a real-estate bust after years of speculation, banks saddled with mountains of bad debt, interest rates heading lower as policy makers try to goose a slowing economy.
The developments have some currency traders asking the previously unthinkable: Could the U.S. dollar slowly be turning into the Western equivalent of the yen?
Other central bankers have been reluctant to act as the Fed slashes interest rates. In places such as Europe, they are worried more about inflation than economic collapse. The disparity in policies could turn the dollar into one of the world's lower-yielding currencies -- and a vehicle for something that investors call the carry trade, in which they borrow money in a low-yielding currency and use it to invest in assets denominated in higher-yielding currencies.
Japan's yen has been the carry-trade vehicle of choice for years, given the country's superlow interest rates. The Swiss franc has been another. If the Fed keeps cutting rates, carry-traders might line up to ride the dollar like a birthday pony, with important implications for markets and the economy.
"The dollar is now generally looking like a low-yielder," says Alan Ruskin, international strategist at RBS Greenwich Capital. "If the fed-funds rate got below 3%, it would establish itself as that."
If the dollar becomes a carry-trade object, the Fed's job would become more difficult. Carry-trade currencies face steady selling pressure -- traders are essentially betting against the dollar. A weak dollar could in turn keep inflation risks alive, by raising the cost of imports. But Fed rate increases to fight inflation would threaten economic growth and potentially cause waves of market turmoil with all manner of trades pegged to the currency.
Yes, interest rates are very low and the U.S. economy is working its way through the destruction of a massive amount of capital. While that condition prevails, which it may for months to come, there may well be a profitable "carry trade" in the U.S. dollar. In the medium to long run, though, the United States economy will have a much higher rate of return than Japan or Europe. Why? Because unlike those other countries our population is still growing, our labor markets remain fluid (despite the best efforts of the trial lawyers and the paternalists), we are relatively unregulated (ditto), and we have a vibrant venture capital market to drive innovation. Even when we are in the doldrums Americans start more businesses than the Japanese, and American investors demand that those businesses be structured to generate double-digit returns on equity over the long term. Yes, a Euro invested in Europe will return more this year than a dollar invested in the United States, but does anybody think that it will over the next five years?
The United States economy will come through this credit crunch just as it has survived every other credit debacle of the last thirty years. Unless, of course, we decide that the pain of economic disorder is so unacceptable that we need massive new regulation of business. I hope we do not decide that, because economic disorder is the fountainhead of opportunity, and opportunity is what makes America the land of second, third, and fourth chances.
2 Comments:
By 
Who Struck John, at
Mon Jan 28, 07:56:00 PM:
The "dollar carry trade" theory belongs in the same dustbin as the "decoupling" theory, and for much the same reasons. When the world's comsumer of choice quits consuming, it's a challenge for everyone to adjust to.
By 
, at
Mon Jan 28, 08:59:00 PM:
