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Nice chart Hilary

Prepare for a very weak dollar

The dollar is on the slide. The consequences for all of us will be profound.

In the red

The essence of the problem can be stated simply. For many years now, Americans have been spending freely, while people in the euro-zone and Japan have not. And Americans have a strong appetite for goods and services produced abroad. The result is an enormous and still-growing current-account deficit with the rest of the world.

As our top chart shows, this amounts to almost 6 per cent of America's GDP. In plain English, this means that American income from the rest of the world, from exports of goods and services and investment and other income, is considerably exceeded by what America buys from, and remits to, the rest of the world. In fact, the gap currently stands at more than $600bn per year.

It has been quite fashionable, of late, to denigrate the importance of the current-account deficit. After all, it has been around for some time. Moreover, in today's sophisticated capital markets, there is no problem financing such a deficit - particularly not for the United States, which can effectively issue IOUs in its own currency. In any case, the US is a fast-growing country, so private capital should be flowing to the US.

But these arguments are dangerously wrong-headed. Of course the deficit can be financed, but at what price? As for capital flowing in to the US, whereas it was true in the boom years of the late 1990s that large amounts of finance came in the form of real investment in plant and machinery or the purchase of American companies, now the overwhelming bulk of the finance comes in the form of the purchase of US securities by Asian central banks.

Solutions

How can the deficit be corrected? There are three ways: Americans can be persuaded to spend less; foreigners can be persuaded to spend more; and/or both Americans and foreigners can be persuaded to spend a higher proportion of their overall expenditure on American-produced goods and services. The first would undoubtedly work but it would hardly be the answer to a maiden's prayer.

It would imply weaker growth in the US, at a time when the economy has been recovering only fitfully and unemployment remains high. Moreover, this would impose pain on the rest of the world, as it would be able to export less to America. The second is the answer to prayers from maidens and matrons alike - but how do you achieve sustained rapid growth in domestic demand in the euro-zone and Japan? There are things that could be done, but both the structural economic barriers and the self-inflicted political obstacles are enormous.

So, we are left with the third path. The dirigiste way of achieving a higher share of your domestic market is through protection; the market route to achieving a higher share of both domestic and international markets is through a lower exchange rate. That is indeed the solution that the financial markets are starting to impose.

Consequences

What would be the consequences of a sharp fall in the dollar? If world portfolio managers were to shun dollar investments, that would potentially cause a significant problem in American capital markets. In particular, there could be a sharp sell-off in American bond markets. But this is nothing compared to the improvements in American competitiveness that would be wrought by a much weaker dollar. And the key point is that, if the weaker dollar did turn round the current account deficit, then America would be less dependent upon the flows of Asian capital.

The real losers from a weaker dollar would be outside America. If the Chinese and other Asian currencies do not rise against the dollar, then all of the dollar's ebbing strength will shift into the euro. People often ask how the euro could possibly rise against the dollar when the economic fundamentals of the euro zone do not look very good. Their concern is understandable but misplaced.

Strong currencies do not always go hand in hand with strong economies. Moreover, in this case, it is a matter of the absence of alternatives. It is not so much that there are good reasons why the euro should be strong; rather, there are good reasons why the dollar should be weak. And the euro is still under-represented in world-asset portfolios, while dollars are continually pumped out by the US.

The economic consequences for Europe would be serious. The euro-zone economy is still limping along. In Germany, consumer spending is stagnant and such economic growth as there is is driven largely by exports. The economy needs a stronger currency like it needs a hole in the head. European Central Bank officials mutter about the need for higher interest rates. Frankly, they are deluded. If the dollar falls sharply then the ECB will have to think about cutting interest rates.

This logic is not lost on the American administration. They are frustrated with the poor growth rates in Europe and Japan. If, by their talk, they can encourage the markets to produce a much lower dollar that will suit their book. Not only would this help to reduce the American current account deficit and boost American output, but it would also put pressure on the rest of the world to boost domestic demand. In this way, a weaker dollar might, after all, prove to be good news, not just for America but also for the world as a whole.

Here in the UK, our position is more complicated. Recently, as our lower chart shows, the pound has tended to rise against the weak dollar but to fall against the euro. Particularly now that the housing market seems to have turned and consumers finally seem to be feeling the pinch, it is vital that we at least achieve this intermediate position. If the pound were to attach itself firmly to the euro and rise the whole hog against the dollar, and not weaken against the euro at all, that would be very serious for our exports.

In fact, I am hopeful that, as the housing market slackens off and the prospect looms of much lower interest rates, the pound will weaken independently, allowing it to fall sharply against the euro and to remain roughly constant, or even eventually to fall, against the dollar. This would allow us to hold our own in the scramble for market share in world markets.

Let the glitterati in Brussels luxuriate in the virility symbol of a strong currency while we reap the real benefits of a competitive exchange rate. After all, if you have chosen to stay outside the single currency to allow flexibility, then you might as well use it.

Hil: Can you tell me the source of your post above (#2031)?

Cheers, D.

Today's Money section in the Sunday Telegraph

http://money.telegraph.co.uk/money/main.jhtml?xml=/money/2004/11/21/ccecag21.xml

Thanks -- found it in the ST Business news in the print edition.

MM,

Glad you've found the article.

Hil:

One of the things I have to struggle with is if/when/how much to adjust my product prices in the U.S.

It's the exporter's dilemma, especially with the U.S. Americans expect software products (like oil) to be priced in dollars, and I've long held that companies like mine can't keep requoting American buyers with every tick of the Cable. They'll just buy from the American competition where the price doesn't change every damned day.

However, it looks like the next improved versions of our products are going to have to be priced to reflect those improvements or we're going to suffer long term bottom-line attrition, a nasty business.

Cheers

D.

Cable's up 100 odd pips this morning and the joker on Bloomers is talking about the $ being strong this morning. What drugs is he on?????????

Here every day (Change the date for reference) Is a run down of what happend yesterday and the reasons why (Fundamentals). Its usefull to see the underlying reasons a move happened.

http://money.cnn.com/2004/11/22/markets/markets_newyork/index.htm

Is there something similar somewhere for Currencys? Even particular pairs say Cable?

Also if Bond Prices are down what does that mean for Stocks and Currencys?

Try this link Tellon.

You need to bear in mind though that traders tend to take their positions based upon the charts. It's easy to then fit the news retrospectively back to the scenario which has actually panned out.

Re your problems with developing a strategy, I'm trying to think of a way to help you. Are you around at about 7:30 in the morning?

Thanks for the link, I have found these updates to be slow sometimes?

I was just looking for pattens within the movement and the news. My main focus is the charts though.

Any help would be very much appreciated. Currently Im keeping a journal of the charts with some note on my thoughts and some breif news/fundamentals and seeing how it pans out compared to my take on the charts.. So far looks like you follow a trend when it breaks you reverse. Ocasionally a trend can continue but the loss can be small before you get back in.. I found divergence can help predict these times.

Unfortunatley I work shifts so this week im around from 9am - 6pm. At 7.30am tomorrow I could be around for about 15mins but then would need to leave to commute. What did you have in mind?

Next week im around from 8am - 5pm and then 7am - 4pm the week after..

Damn Day Job!

Tellon,

If you enable your internal e-mail, I'll aim to send you an internal e-mail at around 7:30am explaining briefly my own strategy for the day including a stop loss level.

Hilary

I wud also appreciate a copy via email if convenient. I may be able to find out where my strategy is falling down.

Regards

I think I have enabled it.. Give it a try..

I appreciate your help Hill..

I have a small JPG showing how im looking at the market at the moment. Anyway I could send this to you just so you could have a quick look tell me if im looking at things in a sensible way. Its based on the DOW but the idea would work on any market.

I have no webspace so cant host to post on the BB.

Tellon,

If you're looking at any time frame longer than 24 hours there is only one way to look at the market atm ....... short Dollar.

If you're looking at a daytrading time frame, then it's not really worth looking at outside of the hours 7am - 2pm, imo. The action is all but done and dusted for today ...... it's just a question of how tight your trailing stop which will take you out of the market for the day (if it hasn't already been triggered).

Bob,

I'm happy to copy you in on it, but I don't want to find myself in the situation where I'm entering into protracted correspondance with everyone on the board. Not being funny.

Using my stratgey it would be long Euro from 1.2850 (Stop would now be at 1.2960) So far it agrees with your take so thats one good thing.

Look forward to seeing you strategy thanks again for your help..

Hilary

Can I join the party please, I am a bit new to this game, tried scalping with moderate success, been spread betting cable for about 3 months, lost a bit gained a bit but about even now, seems scalping for about 10 pips works most of the time but I tend to get stopped out a lot, so am trying longer term with smaller bets with a very wide stop which appears to be working at the moment.