At times one can miss the forest for the trees !

Sometimes in the course of trying to decipher the story that the markets are busy “writing”, one tends to get so embroiled in the minutiae of daily price action so as to lose sight of the bigger picture unfolding. All of us who have ever traded for any length of time are guilty of this and for the better part of the past few months I have been, apparently erroneously, arguing for the dollar to strengthen over the medium term horizon. I still believe that there is merit to the arguments that I had outlined in previous posts,especially the notion that historically the strongest country/economy should have the strongest currency and I had made the assumption that since the US had been more proactive at the onset, it would stand to reason that their economy would be relatively stronger than the rest once the panic etc. had subsided, but the fallout from the latest G7 meeting (Oct 2-4) and the subsequent market reaction has forced me to re-think the entire premise or at the very least, the timing of the conclusion.

It is becoming rather clear that the US has embarked on a unofficial weak-dollar policy as it attempts to become more of an export driven economy to try and alleviate the imbalances that were created over the course of the past decade and all the talk to the contrary is well just that… talk! The foreigners are worried about a weaker dollar as this will damage their ability to export thus jeopardizing any chances of an economic recovery but they contradict themselves by also being critical of the ever expanding US trade deficit and frequently call for correcting “global financial imbalances”. Using the dictum that Conan-Doyle made famous through his fictional character Holmes… “when you have eliminated the impossible, whatever remains, however improbable, must be the truth.”, one can conclude that this “contradiction” is not lost on these brilliant people and that their posturing is aimed at appeasing their local constituents and what they really want is very much in line with what the US wants, namely a WEAKER dollar! [pull up any major chart and look at the price action since march of this year and the old adage that a picture is worth a thousand words is borne out …again!]

The reality of the matter is that the dollar’s more or less continuous decline against other major currencies has helped cut the huge U.S. deficit in trade and financial transactions with the rest of the world and, while millions of Americans have lost their jobs during the severe recession triggered by the financial crisis, the thinking is that without the weaker dollar, many more jobs would have disappeared. The cheaper dollar has helped reduce demand for foreign-made goods and services at home while making U.S. exports more competitive abroad, but while there is global agreement about the necessity of reducing the US trade deficit, there is also “agreement” that this should be done at the expense of someone else. (Europe wants Asia to appreciate Asia wants Europe to bear the brunt to correct this imbalance). This brings to light the conflict inherent within this policy namely that it is impossible for everyone to export their way out of this mess without giving rise to the inevitable tensions between the major economies.

For now, perhaps in the interest of global recovery, the dollar is being allowed, possibly even encouraged, to depreciate but there will come a time in the not too distant future where the calls for reciprocity will begin to grow louder as the currently simmering trade tensions will begin to boil and that is when the plot will really begin to thicken, but until then, any strength exhibited by the US unit has to be viewed in the context of the “new” global initiative.

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