Dollar Rescue?

US, Europe, Japan Planned March Dollar Rescue

By Reuters | 27 August 2008

NEW YORK, Aug 27 (Reuters)— The United States, Europe and Japan had planned to intervene and rescue a weak U.S. dollar in March, business newspaper Nikkei reported on Wednesday. Officials from the U.S. Treasury Department, Japan's Finance Ministry, and the European Central Bank reportedly drew up a currency contingency plan to be undertaken over the March 15-16 weekend, Nikkei reported, citing sources familiar with the situation. The monetary officials also agreed on a framework for coordinating dollar-buying intervention, the report said.

The officials did not specify an exchange rate for initiating the dollar rescue plan, but in the event of a free-fall, they all agreed to aggressively buy the greenback and sell yen and euros, according to Nikkei. Under the intervention framework, Japan was to supply the yen necessary for the underlying currency swaps. The plan also called for using a previously established swap mechanism between the United States and Europe.

No coordinated intervention took place, however, as the dollar began recovering shortly after U.S. authorities brokered the buyout of Bear Stearns by JPMorgan Chase & Co. As measured by the U.S. dollar index, the currency hit bottom on March 17, the first market day following the Bear Stearns deal announcement. It retested those lows in April and again in July, but is now nearly 9 percent stronger against the basket of major currencies included in the index.

A U.S. Treasury spokeswoman declined to comment on the report. The Federal Reserve also declined to comment. A spokeswoman for the ECB said she had no immediate comment, but said the central bank would talk about the situation in the morning. Overall, analysts said that even though a rescue plan never took place, the fact that global monetary officials showed concern for a weak dollar was significant. "If anything, the fact that officials recognized the concern about the dollar's decline seems somewhat supportive for the dollar as maybe benign neglect was not so neglectful," said Marc Chandler, head of global FX strategy at Brown Brothers Harriman in New York.

"At the end of the day, however, President Bush is still set to be the first American president since at least the break-up of Bretton Woods that has not authorized intervention in the FX market, and given the recent price action the distinction looks relatively safe." The United States, Europe and Japan have not intervened together in the currency market since September 2000. Japan's last intervention was in March 2004. (Reporting by Gertrude Chavez-Dreyfuss; Editing by Leslie Adler)

Meanwhile, foreign central banks are buying U.S. dollar-denominated bonds at a furious pace. Why? No one seems to know. But holdings of U.S. Treasury securities have increased at a 34% annualized pace over the last three months. And, it looks like a dollar rebound is firmly in play, thanks to tighter credit conditions in the U.S.(?)

From a fundamental perspective, something has changed: For the first time in 20 years, the supply of credit around the world is drying up. Consider the availability of credit in the United States. Mortgage lending, the engine of our economy for the last 10 years, has ground almost to a halt. You cannot get a cheap mortgage anymore, and you can only get a mortgage if you've got an unblemished credit history.

That's a radical change from only two years ago. Likewise, all U.S. banks have tightened their lending standards across the board and have moved rates higher. While the Federal Reserve has been making credit available to troubled investment banks, the size of its overall balance sheet has barely grown at all— up only 2.1% in the last 12 months.

The Fed can't permit the money supply to grow while it has interest rates set so low. The resulting inflation would be catastrophic. So... even though credit is cheap to banks, it is also very tight for the first time in two decades [[and dear for the 'rest of us'— who were scarcely responsible for this fiasco: normxxx]].

It should not be any surprise that the USD may find broad support and even open intervention. In 10 years USD Reserves have risen nearly 500%. The world is flooded in US Dollars and yet economies are suffering. It should not surprise anybody that inflation has set in— I also do not realistically see the Central Banks throttling their money growth.

If an unforeseen event should occur and drive out holders of the US Dollar, this would cause a large drop in the US Dollar value. The fact that the share of official reserves being held in dollars has remained broadly constant, while the dollar has seen a large depreciation, implies that central banks have been large buyers of dollars. There is thus still fundamental support for the dollar from official reserve flows, which is acting to curb some of the depreciative pressures from the general economic fundamentals. That the dollars reserve share has not seen a marked fall is naturally positive and the dollar would likely have fallen even further in recent years had it not been for these fundamental flows.

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Normxxx    
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