If you believe central banks, currency market management is just rhetoric

Paulson, Trichet Welcome Dollar's Recovery Since G-7

By John Brinsley and Christopher Anstey
Bloomberg News Service
Saturday, May 10, 2008

http://www.bloomberg.com/apps/news?pid=20601080&sid=aIwAaryrPsUQ

WASHINGTON -- U.S. and European officials signaled satisfaction that the dollar is stabilizing after Group of Seven policy makers expressed concern a month ago about its decline.

The dollar has advanced 3.4 percent from its record low of $1.6019 per euro on April 22, and is up 2.1 percent since the G-7 central bankers and finance ministers met in Washington April 11.

European Central Bank President Jean-Claude Trichet said May 8 he "would be happy" if traders take account of Treasury Secretary Henry Paulson's admonitions that the U.S. wants a "strong" dollar. A Treasury official said on condition of anonymity yesterday that the G-7's statement was aimed at getting investors to look past short-term U.S. financial-market turmoil.

"They've got to be quite happy as things are moving in their favor now," said David Gilmore, a partner at Foreign Exchange Analytics in Essex, Connecticut. "There's a sense the market is finally getting the message of the G-7."

While the dollar's drop helps spur U.S. exports, it has also fueled a record commodity-price surge that is hammering consumers. The G-7 last month warned against "sharp fluctuations in major currencies" that could have "implications for economic and financial stability."

The Federal Reserve's major-currency dollar index has appreciated 2.5 percent from its record low of 69.26 in March. The currency was propelled by signs the Federal Reserve is ready to hold off on further interest-rate cuts after seven reductions since September and by speculation the worst of the credit crisis may be past.

... 'Role to Play'

"The G-7 statement had a role to play in the recent bottoming out and recovery of the dollar," said Michael Woolfolk, senior currency strategist at Bank of New York Mellon Corp. in New York. "It shows you have to have a rhetorical plan to show confidence in the dollar. The rally isn't over by any means."

Trichet told reporters two days ago that "I was taking for real and serious what was said by the U.S. authorities, the president, the secretary of the Treasury, and the chairman of the Fed, namely that a strong dollar was in the interest of the U.S.," referring to comments by Paulson, President George W. Bush, and Fed Chairman Ben S. Bernanke.

Paulson said May 8 in Kansas City, Missouri, that "of course it's in our nation's interest" to have a strong currency. He added that "the long-term fundamentals of the U.S. economy will be reflected in our currency."

The G-7's new language on currencies last month was the first significant change since a February 2004 meeting in Boca Raton, Florida.

... Commodity Prices

The International Monetary Fund said May 8 that the dollar's decline has exacerbated the global commodity price boom. The Reuters/Jeffries CRB Index of 19 commodities has climbed 21 percent in the past six months. Oil and other major commodities are priced in dollars in international markets.

Research by the Washington-based IMF indicates that if the dollar hadn't fallen from 2002 to 2007, oil prices would be $25 a barrel lower. Crude oil futures surpassed $126 a barrel for the first time yesterday. Commodity prices excluding fuel would be 12 percent lower, John Lipsky, first deputy managing director of the IMF, said in a speech in New York two days ago.

"If the dollar depreciates a bit, then you would expect to see commodity prices rise to offset that depreciation," Bernanke told U.S. lawmakers at a congressional hearing March 28. At the same time he noted that oil prices have also risen in dollar terms.

... Intervention Window

While the G-7 hasn't intervened to affect exchange rates as a group since 2000, the dollar's stabilization now offers a chance for officials to secure a convincing rebound, said Gilmore and Tony Crescenzi, chief bond market strategist at Miller Tabak & Co. in New York.

"The entire world is aching from what's happening in commodity prices and the burden is on the G-7 to do something," Crescenzi said. Without coordinated intervention, "there's a big risk of a setback in the dollar that creates more political turmoil around the world as we have seen."

Japan is the last G-7 member to buy or sell its currency to affect exchange rates, halting a campaign to help the yen in March 2004. The G-7 in September 2000 intervened to prop up the euro. The last time the group bought dollars was in 1995.

"Everybody knows it's symbolic, but traders want to see it because they don't like the idea of benign neglect," Crescenzi said.

Gilmore said intervention is unlikely while the Bush administration is in office, given its preference to let markets work without government interference. The U.S. has refrained from buying or selling its currency since Bush took office in January 2001. They probably view that record as "pitching the perfect game," Gilmore said.

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