IB FX View

Deficits don’t matter: Discuss

Tuesday June 2, 2009

“I worry about details. We will be watching you very carefully.” Those are the words of former Peoples Bank of China adviser, Yu Yongding, assigned to act as the China Daily’s interviewer throughout Mr. Geithner’s visit to his nation according to Bloomberg news. According to media reports, Mr. Geithner is striking a chord with Chinese audiences as he explains the need for elevated U.S. debt issuance in dealing with the financial crisis. His delivery is creating an understanding of the future safety of the dollar, and therefore the manageability of underlying government debt. Mr. Geithner is laying it on thick that demand for U.S. debt will remain elevated across time and that the U.S. will step down its borrowing costs as soon as it is able.


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The future shape of fiscal management is likely to be a huge lesson after this crisis is past. Undoubtedly the legacy will be heavy indebtedness to the rest of the world. Foreign governments bought more U.S. bonds in May adding over $68 billion as the Fed auctioned over $100 billion on behalf of the treasury. If the U.S. is successful in creating the largest public borrowing burden in history at a time of severe financial uncertainty and economic collapse, the question for public policy going forward when the economy is truly on the mend is how to repeat this performance in a well-planned manner to deliver future needs by bringing forward the cost of doing so.

Mr. Geithner might do the dollar a favor while he’s in China if he is indeed successful in undermining current common wisdom that the dollar is toast and that a soaring budget deficit confirms its consignment to the trash can.

Today the dollar has weakened against the euro to $1.4265 while the euro earlier gave up ground to the yen before regaining its poise to 136.87. Earlier, the rate of Eurozone unemployment grew to a 10-year high at 9.2% for April versus a reading of 8.9% for March. Perhaps that’s old news and while not a leading economic indicator the data hardly supports the view that the euro is set to out perform the dollar. Traders sense that the data may increase the chance of more monetary easing from the ECB this Thursday. However, that would likely mean deeper purchases of corporate debt than the €60 billion recently announced. Considering the rationale for recent dollar weakness has been the degree of quantitative easing undertaken via the Fed, the ECB would serve to weaken the euro should it step up its purchases.

While the China tour and the yield of government debt are the vogue items, the dollar has also been partially undermined by increasing chatter about the need for a new global currency. The story is an emergent one from Russia and began in March when President Medvedev pondered out loud the need for a dollar alternative. According to his spokesperson, the president might expand on this discussion later in June when he meets his peers from fellow BRIC nations including heads from Brazil, China and India.

One wonders what might lay ahead for the dollar if the Geithner initiative works. It’s been a rather easy period for investors lately as they react to the perception of green shoots. Buying equities, selling bonds and ditching the dollar have been easy fodder of late. A Geithner reprieve coupled with more uncertainty over European policy settings might harm this pattern.

As we noted yesterday, what the central banks are currently thinking will make for interesting reading going forward. And today we got our first taste of that from the Reserve Bank of Australia, which left interest rates unchanged at 3%. However, they raised the prospects for further monetary easing, which tells us something about the divergent views between central banks and investors. Perhaps that’s partly because the banks are fully aware of the scope of what they have done to reflate the globe. But take it away, and then what?

Andrew Wilkinson

Senior Market Analyst ibanalyst@interactivebrokers.com

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