Don’t deficits matter?

“Don’t deficits matter?” asks Buttonwood at the Economist. She’s not happy that the dollar continues to rally:

The currency has gained more than 10% this year, hitting a two-year high against the yen last week and a three-month peak against the euro. This is despite an American current-account deficit even wider than last year’s and apparently reduced enthusiasm among Asian central banks for dollar-denominated assets. Buttonwood was among those early in the year who expected the dollar to go every which way but up. How wrong can a columnista be? Why didn’t the currency behave as she told it to? Don’t deficits matter?

I hate it when currencies don’t do what columnists say. Here’s the awful admission:

Despite hurricanes, higher oil prices and indeed higher interest rates, America’s economy has grown more strongly than most people expected.

Imagine that! But don’t worry; here’s the mandatory “dark-clouds-on-the-horizon” ending. The dollar is about to crash. It has to crash. It must crash. Run! Hide!!

Yet if all this sounds too Goldilocks to be true, it probably is, for a couple of reasons. Any big upward movement in the dollar’s exchange rate is probably limited by the perception that there are sellers of dollars out there waiting for right price (central banks, especially). “Non-commercial traders” have longer net positions in dollar futures than almost ever before, on figures from the Commodity Futures Trading Commission—always a bad sign. As the dollar strengthens, American investors themselves are pouring money into foreign markets, which in time could blunt the greenback’s rise. Some of Japan’s normally risk-averse investors are stripping off their currency hedges to capture higher yields in America; they could flee at the slightest sign that the dollar is in trouble or Japan’s economic recovery is finally starting to lift the yen. And the euro has lost 12% in value since the beginning of the year. If the ECB starts raising interest rates in the first half of next year just as the Fed stops, it might gain it back.

Or it might not.

Posted by on October 27th, 2005 at 1:06 pm


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