What happened today in the foreign exchange (Fx) markets? The last I looked the Canadian dollar fell 2.53% to US$ 0.9022, the British pound fell 1.92% to US$ 1.6267 and the Euro fell 1.3% to US$ 1.4199. In "normal" times these extreme moves would not occur in a month let alone one day. There was no apparent fundamental reasons for this to occur today. Sure crude oil fell $2.59 to $65.96/bbl which may have some negative impact on the Loonie but why would the BP or Euro fall as well? The UK is a net importer of crude oil as is Europe. Surely they would benefit (though likely not as much as much as the US does) when the price of oil falls. It is apparent to me that this was a co-ordinated hatchet job by the 2 countries and the Euro zone (along with lot of help from Uncle Sam) to sell their own currencies and buy the US$. As a result the US dollar index rose 0.96 today to 79.49 (this a basket of currencies which includes the 3 currencies mentioned above as well as the Japan Yen and the Swiss Franc).
Why would a central bank intentionally manipulate its currency downward? Because they are worried that their exports will suffer if their currency strengthens too much (and too fast) against their major trading partners. So what we saw today was an attempt to debase three major currencies in order to make the sick US$ look better. This is akin to a person taking low doses of poison in order to make a friend who has cancer feel better about his condition. Of course it doesn't help either party and in the end may prove fatal for both.
The US$ index had fallen quite steadily since its high of 120 in January 2002 to its low of 70.70 on March 17 2008. From there it had a nice bear market rally to 89.62 on March 4 of this year whereupon it started to resume its long term decline to 78.33 touched yesterday until the central banks started manipulating the currency (my belief, not fact). This of course is all a waste of money as manipulations of this kind can only have a short term effect until the market decides to resume its long term trend. Central banks cannot control the Fx market with their manipulations for long.
The US is petrified of seeing their currency retest the recent low of 77.69 reached on December 18 2008 since it is likely to fail. Once this level is breached it will likely fall quickly to test the 75.89 handle reached September 23 and should that fail it will likely fall all the way to its all-time low of 70.70 on March 17 2008. After that we are in unchartered territory folks so anything can happen. If the US does not get its fiscal house in order by drastically reducing spending and start to grow its GDP to levels at least as high as those projected (or rather hoped for) by the Obama administration over the next 5 years the world will completely lose confidence in the US$. This would not be a good thing for world trade and hence our standard of living since the US$ is by far the world's major reserve currency.
When will the Obama administration step up and do the right thing? It is pointless to keep playing these confidence games in an attempt to convince (fool) the public that the economy and monetary policy are doing well and are under control of the supposedly omnipotent and omniscient government. Debt must be reduced, not increased by the unimaginable amounts being attempted by the US government in a futile effort to re-inflate the already burst housing and stock bubbles that they created over the past decade or more. There is not much time left to change course. Government spending must be reduced and brought under control quickly. In addition, taxes must increase. I know that this flies in the face of neo-Keynesian thought but we have come to a crossroads (or Morton's fork) here. Either we allow the markets to deflate quickly, take the pain and start to rebuild a stronger economy that is not centrally controlled by governments and central banks or we will experience the unbelievable pain of hyperinflation as all world fiat currencies implode. Neither choice is desirable but one will be taken whether intentionally or not. I prefer the deflationary route as the lesser (just barely) of two evils.
As Yogi Berra once said: "When you come to a fork in the road ... take it."
Gerry
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