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Gold price trails oil by more than ever
Wall Street, Fed At Odds
On Effect of Any Dollar Collapse
From Reuters
Friday, August 26, 2005
http://today.reuters.co.uk/investing/financeArticle.aspx?
type=usDollarRpt&storyID=URI:urn:newsml:reuters.com:20050826:MTFH2666
3_2005-08-26_16-35-57_N26409411:1
NEW YORK -- Although a dollar crash is unlikely any time soon, a
Federal Reserve study says any collapse in the value of the currency
is unlikely to hurt the U.S. economy. But few analysts agree.
Instead, many economists suggest an abrupt decline in the dollar's
value would cause pandemonium in both U.S. credit and equity markets.
To maintain foreign interest in U.S. financial markets and prevent
large investment outflows, which would disrupt the economy, the
central bank would begin raising short-term rates aggressively,
analysts say.
But rising short-term rates alone would choke U.S. economic growth
as American consumers would be inclined both to save more and borrow
less. Since the United States buys goods from around the globe,
analysts emphasize that the spillover would be worldwide.
"A dollar collapse would hurt everyone -- in the U.S. and around the
world," said Joe Quinlan, managing director and chief market
strategist with Bank of America Capital Management.
"It would force the hand of Europe, Japan, and Asia and force these
nations to undergo consumption-led growth, a dynamic they have long
resisted."
As U.S. consumers stop buying, it would also disrupt the established
pattern of U.S. consumption being financed by the countries,
particularly China and Japan, that actually produce those goods.
Since most of the dollars collected by those countries are used to
buy Treasuries, the U.S bond market could suffer a sharp selloff
that would push rates up in the long end of the yield curve as well,
analysts say.
The Fed, though, is at odds with the thinking on the street,
according to its recent report.
"Currency crashes do not generally lead to higher bond yields in
industrial countries," the study said. "Indeed, over the past 20
years, currency crashes in industrial countries have always been
followed by falling bond yields."
While Joseph Gagnon, assistant director of the Fed's Division of
International Finance, notes in the study that currency crashes in
the 1990s in Mexico and East Asia did push long-term rates up to
debilitating levels, he added that rich countries appear better able
to deal with the threat because of the inflation-fighting
credibility of their central banks.
Gagnon found the change in bond yields after a currency crash was
strongly linked to the level and change in inflation after the crash.
The U.S. experience since 1970 has been limited to just one dollar
crash, in 1985-86, Gagnon said. In that time, the U.S bond yield
dropped more than 4 percentage points, counter to what Wall Street
would anticipate.
Investors, though, are not convinced.
"The Fed's study is flawed as the comparisons are not relevant,"
said Peter Schiff, chief global strategist with Euro Pacific Capital
Inc. "When the world dumps dollars, they will also dump Treasuries,
sending rates soaring."
Schiff, who is bearish about prospects for the dollar, says the most
interesting thing about this study is not its "ridiculous
conclusion" but the fact it was even done.
"If the Fed is studying the effects of a dollar collapse, they must
actually believe that one is possible," he said.
To be sure, others who differ with the Fed over what would happen if
the greenback were suddenly to fall are not necessarily expecting it
to happen.
"I'm not in the dollar collapse camp -- U.S. assets remain among the
most attractive in the world, assuming no more U.S.-led wars, no
U.S. protectionism, and the continued outperformance of the U.S.
economy relative to Europe and Japan," said Bank of America's
Quinlan.
Anthony Chan, Columbus, Ohio-based managing director and senior
economist at JP Morgan Asset Management, agreed with Quinlan.
"A decline in the value of the dollar sometimes spooks foreign
investors, in both equities and fixed income, since they now have to
incorporate a currency loss into their investment equations," he
said.
"Although this only comes into play when the decline in the value of
the dollar is abrupt and significant --- a small orderly decline is
not likely to incite such a negative response."
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