Dollar may feel sting after G7 complains about China
[The writing is clearly on the wall. It's just a matter of time. – MCR]
by Kevin Plumberg
Reuters
Washington
Saturday, April 22, 2006
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The overall message that markets will take away from finance officials from the Group of Seven rich nations who met on Friday is quite simple: The dollar will decline.
The ominous combination of a widely forecast slowing of the U.S. economy this year, growing fiscal and trade deficits, and increasing international pressure on China to allow its currency to strengthen ultimately puts a spotlight on the dollar's weak underbelly.
"You would have to be blind, deaf, and dumb not to see that as pointing to a direction for the dollar," said David Gilmore, partner with FX Analytics in Essex, Connecticut.
In its post-meeting statement, the G7 finance ministers and central bankers stepped up pressure on China by naming -- twice – the world's fourth largest economy as one of the "emerging economies with large current account surpluses" that needs to allow more flexibility in its currency.
In fact, in an annex to the statement, which focused on repairing global imbalances between some countries that run relatively huge trade deficits and others that have large surpluses, the G7 officials said greater flexibility in China's yuan is needed to allow "necessary appreciations."
Some analysts viewed such pointed pronouncements as a measure of how unsustainable the U.S. trade deficit -- which last year widened to $723 billion, nearly 6 percent of gross domestic product – has become.
"What might prompt some dollar fears is that the United States is closer to admitting the deficits are a big problem," said Naomi Fink, currency strategist with BNP Paribas in New York.
At $875.1 billion, China's central bank holds the world's largest foreign currency reserves, partly because Beijing regularly buys dollars to hold down the value of the yuan.
"This is not a flashing sell signal for the dollar," noted Gilmore, who called the inclusion of China's name in the G7 communique an "evolution" of international views that would weigh on the greenback over time.
Participants in a conference on global imbalances sponsored by the International Monetary Fund were told the U.S. economy will likely slow along with the pace of consumer spending and that could ultimately drag the dollar down.
The dollar hit a seven-month low against a basket of major currencies this week as financial markets reduced their expectations that the Federal Reserve will raise interest rates beyond 5 percent, following softer-than-expected U.S. economic data and comments from Fed officials.
Last year, the dollar halted a three-year decline as the greenback's interest rate advantage widened over some other currencies because of the Fed's two-year credit-tightening campaign, which has lifted overnight rates to 4.75 percent from 1 percent.
But recently the dollar's so-called structural vulnerabilities have been once again haunted the currency.
On Friday, the dollar tumbled against the euro after the Russian finance minister questioned the pre-eminent reserve status of the greenback because of its recent volatility and the sheer size of the U.S. trade deficit.
"There are some jitters out there that global reserves will move away from dollars," said BNP's Fink.
In the near term, China's being named in the G7 statement could knock the dollar lower against the yen.
"It is a strong statement," said Steven Englander, chief North American foreign exchange strategist with Barclays Capital in New York.
"The risk is dollar/yen. We are closer to pain levels for investors who are long dollar/yen," he said. Being long a currency is essentially a bet that it will appreciate.
Against the yen, the dollar on Friday slipped to 116.52, the lowest in a month after a draft G7 statement obtained by Reuters named China as a country where greater currency flexibility is needed. China closely manages yuan exchange rates.
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