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Mix-Ansicht- Morgan Stanley: Zum assymetrischen Dollar-Verfall - kingsolomon, 25.05.2003, 10:37
Morgan Stanley: Zum assymetrischen Dollar-Verfall
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Currencies: On the Symmetry of the Structural Dollar Correction
Stephen L. Jen (London)
Focussing on the “symmetry” aspect of the USD decline
In this note, I present my thoughts on the “balance” of the structural USD correction. Now that a USD correction is (finally) a consensus view, I believe it is important for us to be pay attention to the “breadth” and “symmetry” of this USD correction, not just to debate whether or not the USD will or should go lower, because the excessively lopsided USD correction could jeopardise the sustainability of the USD correction.
The USD correction has thus far been (1) more concentrated against the majors than against the minors, and (2) more tilted in favour of the EUR than against the JPY. This is problematic, in my view. Unless the USD correction broadens more into the minors and rebalances from the EUR to the JPY, the sustainability of the USD correction may be jeopardised, because excessive pressures would be concentrated on a few currencies like the EUR, CAD, and AUD to absorb the USD weakness.
The major-versus-minor disparity
One source of the structural dollar correction is the US current-account (C/A) deficit, which the US runs against both developed and developing countries. This means that, for the USD correction to facilitate the normalisation of the US goods-market imbalances, it should correct against a broad array of currencies, both major and minor. While a concentrated USD correction against major currencies could still effect a meaningful change in the overall relative price of US tradeables, a broader USD correction should help spread out the adjustment pains across a broad range of economies. This, in theory, should enhance the sustainability of the USD correction. For example, an excessive adjustment against the EUR could lead to serious fractures in the Euroland economy and, finally, to a sharp weakening in the EUR, undermining the USD correction.
The Fed’s major and broad USD indices are useful for tracking this disparity in the USD correction. The Fed publishes three key USD indices: (1) the broad USD index, with 26 currencies, (2) the major USD index, with 7 currencies (AUD, CAD, EUR, JPY, SEK, CHF, and GBP), and (3) the OITP index, or the Other Important Trade Partners Index, consisting of the remaining 19 currencies not in the “major” index (Argentina, Chile, Colombia, Mexico, and Venezuela in Latin America; China, Hong Kong, India, Indonesia, Korea, Malaysia, the Philippines, Singapore, Taiwan, and Thailand in Asia; Israel and Saudi Arabia in the Middle East; and Russia in Eastern Europe). The major USD index accounts for about 57% of the broad USD index, while the OITP index accounts for rest.
Looking at the performance of these 26 currencies against the USD since 2001, we see that although the USD has indeed corrected against many currencies, it has also appreciated against many emerging market currencies. This is why the overall decline in the broad index is so modest. Looking at the relative movement of the broad and the major USD indices since the beginning of 2002, we see that the narrow index has declined by around 18%, while the broad index has fallen by about 8%. The ratio between these two indices is a measure of how fast the USD correction is “broadening out” into emerging-market currencies. While the ratio of the cumulative movement of these indices since the beginning of 2002 is around 2.1, it hides the fact that this ratio has plummeted in recent weeks. Let’s call this the “broadening ratio” of the USD correction. The broadening ratio was 3.4 during 2002, declined to 3.0 by end-March, but plummeted to 2.1 currently. The currencies that have been “catching up” recently include BRL, ARS, ILS, IDR, and RUB. Bear in mind that these ratios are based on the cumulative changes in the two USD indices since the beginning of 2002. The sharp drop in the broadening ratio implies that the emerging-market currencies, collectively, have been rapidly catching up to the developing-market currencies in recent weeks. To the extent that the broad USD index better captures the overall price sensitivity of US imports, the closer the “broadening ratio” is to 1, the “healthier” is the USD correction, from the goods market perspective.
The Europe-versus-Asia disparity
In addition to the issue of how the USD correction is “broadening out” into the minors, there is also the issue of “symmetry” between the European currencies and the Asian currencies. This is a point I have been making for some time now. I have argued that, since around 46% of the US bilateral trade deficit is against Asia, compared to only around 14% against the Euroland economies, a USD correction that is lopsided in favour of the EUR is highly “inefficient” in effecting the desired normalisation in the US external balance. In other words, given the massive out-performance of the EUR, the current-account (C/A) correction of the US has been forced on the Euro-area, not against Asia.
Further, the fact that the Asian currencies are falling against the USD is raising another concern. Let me reiterate an idea I have discussed before. The US is the largest marginal consumer in the world, while, collectively, Asia is the largest marginal producer in the world. When the USD and the Asian currencies fall, the purchasing power of the US declines, while the competitiveness of Asian production is enhanced. For the rest of the world (i.e., Europe), this is a highly deflationary combination, as it is hit by a withdrawal of demand and an injection of supply. In sum, the likely net effect of the current exchange rate trends is that the deflationary shock on Euroland could be much more intense than the European policy makers have in mind.
The USD adjustment is also problematic, due to US price elasticity of export demand. The whole theoretical basis in support of a weak USD, from the US perspective, is that a weaker USD would make US products more competitive abroad. However, the importance of this effect is a function of how sensitive US exports are to changes in the exchange rate. My idea is that exports to Asia react much more strongly to changes in USD/Asia exchange rates than exports to the Euro-area do to changes in EUR/USD. In other words, I believe the demand curve for US exports that compete in Asia could be much flatter than that for US exports that compete in Europe, due to differences in the price competitiveness of the goods in question. Thus, to the extent that most of the USD correction has come through against the European currencies, and that the export demand curve against Europe is steep, then the overall decline in the USD index over-states its potential positive impact on US exports. Notwithstanding the J-curve effect, the US C/A deficit is not likely to be responsive to the decline in the USD, until the USD declines against the “right” currencies.
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