Banking on a dollar rally

Bill Jamieson

The stakes could not be higher in the deadly combat between soaring oil prices and the greenback

Who is calling the tune in currency markets? In recent weeks, events on the foreign exchanges have come to resemble a stupendous game of chicken. Which will snap first: the forces behind the soaring oil price, or the forces attempting to mount a sustained rally in the dollar?

The stakes could hardly be higher. On the outcome of this epic tussle depends not just where the dollar and other major currencies are likely to be a year from now, but whether America and the eurozone are destined for mild recession – or prolonged stagflation.

With the onset of the credit crisis last August, the US Treasury was content to see the dollar fall, improving the prospects for American exporters and helping to cut America’s massive balance of payments deficit. Benign neglect of the dollar, it was thought, would help the manufacturing sector and cushion the downturn arising from the subprime mortgage debacle and the worsening slowdown in the housing market. Remarks in February by Ben Bernanke, chairman of the Federal Reserve, on the benefits of dollar weakness for exports, fuelled this decline.

This policy lasted until early May. It then underwent a dramatic change. The soaring oil price – and rising prices of imported foodstuffs – were stoking a potentially severe problem with inflation. The weak dollar, far from being an asset, was now seen as a liability, and one that magnified every fresh surge in the price of oil. Better, it was thought, that the dollar now staged a sharp rally that would help staunch the rise in the oil price and ease pressures on the Federal Reserve to switch from a stance of cutting interest rates to raising them. Thus, from fighting the continuing problems of the global credit crunch, the battle swung to fighting the spectre of inflation.

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Phi1 Edinburgh

July 14th, 2008 10:54am Report this comment

With the current crisis in American banks and mortgage providers the US Government will be taking on billions of mortgage debt - which means the dollar is going to fall not rise!!!!

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