Politics & Policy

Some analysts are surprised by the evident unwillingness of Central Bankers to intervene on behalf of the Dollar, especially considering how common such "rescue plans" are becoming in other corners of the financial markets. Over the last couple months, all of the momentum that was previously behind intervention has gradually evaporated, such that at the recent G8 Summit, currencies were hardly even discussed. This is somewhat ironic considering the Dollar has resumed its downward trend, and even touched an all-time low against the Euro. Treasury Secretary Henry Paulson and Fed Chief Ben Bernanke aren't willing to completely write off intervention, however. Both have commented explicitly that it is still being mooted as an option.

The narrative in forex markets had recently become so cut-and-dried, that investors may have forgotten that in the long-term, a variety of factors weigh on currencies. Last week, they were sternly reminded of this fact when tensions in the Middle East boiled over and sent the Dollar racing downwards. An Iranian missile launch sparked the initial uproar, but was quickly followed by unrelated violence in Turkey and Iraq. First, the price of oil skyrocketed, and then the Dollar fell, consistent with the inverse correlation which has been observed between the two commodities. It is unlikely that geopolitical tensions will supercede the macroeconomic situation; investors continue to monitor the credit crisis and interest rate differentials with vigilance.

The looming possibility of forex intervention in response to the Dollar's continued weakness is causing an uproar in forex circles. Some analysts don't feel intervention is a real possibility because it is so inconsistent with the ideology espoused by the current US presidential administration. In a piece published in the AsiaTimes, however, one expert noted that the history of the Dollar is also a history of intervention. Even when the Dollar was still linked to the Gold Standard, the Fed intervened by buying or selling gold depending on the result it wanted to achieve.

G8 finance ministers met last week to discuss the detrimental effects of rising (commodity) prices on the global economy. Oil prices and commodity prices have in some cases doubled over the last year, contributing  to a nasty surge in worldwide inflation rates. While the Dollar was not technically a topic of the discussion at these particular meetings, it was broached tangentially because of the perceived relationship between the weak Dollar and high commodity prices. Accordingly, Central Bank intervention on the Dollar's behalf could theoretically be justified on the basis of both mitigating inflation and facilitating global macroeconomic stability.

Over the weekend, the people of Ireland resoundingly rejected the Lisbon Treaty, throwing up roadblock in the way of the most recent attempt to solidify the bond of the EU. Surprisingly, the Euro shrugged off the news and actually rose on the first day of trading following the release of the results. This marks a sharp departure from 3 years ago, when the rejection of a comparable treaty by the people of France and The Netherlands caused a panic in forex markets as analysts sounded the knell of the EU. The explanation for the diverging reactions is that the European Political Union has been de-coupled from the European Monetary Union.

The Central Bank of Vietnam has effectively devalued its national currency, the Dong, to bring it in line with market fundamentals. Pressure had been building under the Dong due to soaring inflation, currently estimated at 25%. While 2% devaluation was small in itself, it caps a 5% drop in the currency since March 25. In addition, the move showed just  how seriousness Vietnam is about restoring macroeconomic stability. Unfortunately, Vietnam's balance of trade is probably deteriorating faster than it can be repaired, which means the Dong may slide much further. The black market exchange rate is estimated at 18,000:1, compared to the official rate of 16,461:1. Non-deliverable forward contracts imply a 30% depreciation in the Dong in the next year. The Guardian reports:

When it comes to forex, the old adage actions speak louder than words doesn't always hold. In fact, words can be quite effective on their own in holding down or propping up a currency. For a while, the threat of intervention by the Central Bank of Japan was enough to hold down the Yen, despite a lack of supporting action. With regard to the Dollar, several high-ranking economic officials have recently made unsolicited comments implying that traders should think twice about shorting the Dollar. First, Ben Bernanke worried publicly about the effect of the sinking Dollar on inflation. Then, President Bush suggested that the Dollar was undervalued relative to economic fundamentals.

The Continuous Linked Settlement (CLS) Bank, which performs the thankless job of settling the nearly $4 Trillion in currency trades completed each day, recently announced that it will now settle trades involving the Israeli Shekel. This is quite an honor for Israel, as only 16 other currencies can claim this distinction. Implicitly, the Israeli Shekel has been deemed both important and stable enough to be fully convertible. The announcement marks another positive development for the currency, which has appreciated by an astounding 30% against the Dollar over the last year, including 15% since the beginning of 2008. It is unclear when amateur traders will be able to trade the Shekel, but now that it is included in the CLS roster, it probably won't be long. YNet reports:

Over the last two years, South Korea's overseas borrowings more than
doubled, to $388 Billion. Nervous, perhaps, that Korean businesses may
be overextending themselves, the government is seeking to regulate such activities. Based on the way the forex markets
responded to the news, it must be perceived that borrowing abroad is
helping the Korean economy. On the one hand, if loans are denominated
in foreign currency and must then be converted to local currency, this
would exert upward pressure on the Korean Won. On the other hand, this
also requires more local currency to be printed, which fuels inflation. Much
of the borrowings are being undertaken by shipbuilders who are trying
to hedge their exposure to a rising Dollar. The Edge Daily reports:

Raise your hand if you've ever heard of the Hungarian Forint.  I didn't think so.