THE case for buying the dollar looks stronger than the argument for further weakness.
The world's currency markets are in an uneasy equilibrium. There is a collective shunning of the dollar, reflected in its weakness against other developed economies' currencies and in the rising dollar price of gold.
In late 2008, gold rose because of the uncertainty accompanying the banking crisis, while its strength in 2009 is more related to fears that inflation will debase the value of paper currencies.
In particular, the 20% rise since the end of August (a period of rising confidence in global markets) has been linked to stories that the world's central banks (especially China’s and India’s) wish to diversify their foreign exchange reserves away from the US dollar, in which they are alleged to be losing faith.
Although there is some logic behind the mistrust of paper currencies at a time when many central banks (notably the US and the UK) are increasingly printing currency to boost growth, it is not clear why the dollar should be singled out. The US economy has grown faster than Europe, the UK or Japan for three out of the past four years and is forecast to grow at twice their rate in 2010. Growth in emerging economies such as China is more vigorous, raising questions about why the Chinese authorities do not permit their currency to rise against the dollar.
However, relative economic performance seems a poor reason to be selling the dollar against the currencies of the mature economic regions. The UK economy faces an awkward transition from growth driven by government spending and consumer debt accumulation, suggesting that the currency will need to stay competitive to turbo-charge the manufacturing sector.
Sterling is some 15% lower than its level in early 2008, but has bounced 15% since its lows in early 2009. The euro is trading within 5% of its all-time high against the dollar, yet the Eurozone is expected to grow at barely 1% in 2010, while the yen is trading at its highest level against the dollar for 15 years, at a time when its economy is among the weakest of the developed world and deflation is rife.
Given this litany of economic mediocrity, the case for buying the dollar looks stronger than the argument for further weakness.
The missing ingredient is confidence that the US government is willing to act on its verbal assurances that it wants a strong (or at least stable) currency. The perception is that, when its economy is weak, the US is quite happy to use dollar weakness as a springboard. This has periodically carried it to cheap levels in the past, from which it has subsequently recovered. If the US hits the market's forecast of 2.5% growth in 2010, while other G7 economies deliver only half that, it might not take much for sentiment to change.
We should not be surprised if currency markets deliver a shock to the system in coming months. If this includes the Chinese allowing their currency to appreciate, it would help in rebalancing global growth from the indebted West towards the savings-rich East and make the current economic recovery look more sustainable.
