forex spillovers

[Eubulides <paraconsistent@xxxxxxxxxxx>]

America bets its bottom dollar

The US has talked down its currency to take on the far east, but British
investors are suffering

Nils Pratley
Friday October 3, 2003
The Guardian

It was almost a vintage summer for stock market investors. The FTSE 100
index drifted up gently, encouraged by generally strong figures from
corporate Britain and signs that the US economic revival was accelerating.
With the blue chip index at 4,314 a fortnight ago, more than 300 points
above its level on January 1, the safest bet of all seemed to be that the
stock market would not fall for a fourth successive year.

Then came the International Monetary Fund's meeting in Dubai and the call by
the G7 countries for "more flexibility" in global exchange rates. John Snow,
the US treasury secretary, called it "a milestone change" and the markets
knew what he meant - the US wants a lower dollar.

In itself, that might not be a problem. Given the US's huge current account
deficit, the dollar probably is too high.

One reason for its perceived over-valuation is the determination of Japan
and China to keep their currencies weak to help exports. This year Tokyo has
spent the equivalent of Ireland's GDP in its efforts to keep the yen below
115 to the dollar. So the fact that Japan signed the G7 statement should be
reassuring.

But that is not how stock markets see it. Wall Street and London have had a
serious bout of nerves and the FTSE 100, even after gains over the past
couple of days, has slipped back to 4,209. Part of the decline seems to be
instinctive, reflecting the old rule of thumb that a falling dollar and
falling stock markets go hand in hand.

European fears
The nervousness comes from fear that sterling and the euro could get caught
up in action that is primarily designed to reduce the value of the dollar
against the Japanese yen and the Chinese renminbi. German manufacturers, in
particular, have been complaining about the strength of the euro and the
last thing they want is the euro above $1.20, squeezing profits, adding to
German unemployment and stifling activity across Europe.

In Britain, stock market investors have another worry: some of our biggest
companies pay dividends in dollars. But the pension funds which are the main
owners of UK plc have to pay out in sterling. BP and HSBC - two
dollar-payers - together account for about 18% of the dividends paid by
Britain's top 350 companies.

Investment bank Morgan Stanley calculates that a 10% fall in the dollar
against sterling (it is 8% so far) would have a severe impact. It forecasts
that growth in UK dividends will be just 1% this year and reckons that the
falling dollar last year removed £600m from UK dividend payments. An 8%
decline this year, followed by the same next year, would account for another
£2.4bn. That cumulative £3bn is not theoretical money; it is hard cash paid
by companies from their profits.

If that is a worry, it is nothing compared to the fear that Washington's
lower dollar policy is the start of something more serious - a return to
protectionism. The problem is simple: the US economy is reviving but not
creating many jobs and for that Washington blames the Chinese.

As in Europe, US jobs are effectively being exported to China, where cheap
labour is made even cheaper by the policy of pegging the renminbi to the
dollar.

US politicians, it seems, have had enough. Stephen Roach, Morgan Stanley's
chief economist, last week testified to a congressional committee and was
deeply depressed by the experience. "Like it or not, the politics of
protectionism are rearing their ugly head in the US Congress.

"This is not the view of just a few extremists. America's new-found
protectionism is rooted in the election-year angst of the jobless recovery.
The forces of free trade are silent - unwilling to be characterised as
anti-worker in this climate."

Legislation has been introduced in both the Senate and House of
Representatives that would slap tariffs on China. Markets hate the T-word as
they slow growth and are effectively a tax on consumers.

Mr Roach is stark in his warning: "This is not normal election-year bluster.
Emotions in Washington are boiling over with rare intensity. Hopefully,
reason will prevail and these bills will not pass. But that doesn't alter
the disturbing endgame - protectionist measures are likely in one form or
another. As one seasoned Washington insider put it to me: 'The political
train has left the station. I can smell it - something big is coming. You on
Wall Street need to prepare for it.' "

One way to reduce the tension would be for Beijing to accept that the
renminbi is undervalued. Jim O'Neill, Goldman Sachs's head of global
economic research, says: "We do expect that the Chinese authorities will
move to a more flexible exchange rate mechanism. It might come very soon,
possibly in a matter of weeks."

The nightmare is that the Chinese refuse to budge and the US jobless figures
get worse. The next fortnight should give clues on both scores: the US
treasury is due to testify to Congress on Wednesday week about whether China
unfairly manipulates its currency. Today the US publishes its monthly
employment figures.

So far, the markets are holding their nerve, but pessimistic noises are
everywhere. On Tuesday, Merrill Lynch advised European equity investors to
raise cash, saying the "dollar and the data are raising the risk of
'triple-dip'."

Morgan Stanley assesses the risk of US protectionism as "one in three", so
is sticking to its year-end FTSE 100 target of 4,500 but Graham Secker,
equity strategist, adds: "If it goes to one in two, we would have to reduce
our forecast." Suddenly, summer seems a fond memory.