Euro and Oil Intervention

["Henry C.K. Liu" <hliu@xxxxxxxxxxxxxx>]

The Central Banks of the US, EU, Japan, intervened on behalf of the euro
on September 23, 2000, with the half hearted participation of that
British and Canadian counterparts.  The announcement was a confused and
unconvincing policy gesture.

On the practical side, it was an empty gesture. The CBs bought between
$3 to 5 billion of euros.  The daily turnover in the global foreign
exchange market hovers around US$1.6 trillion.   This volume dwarfs the
combined resources of the G7 CBs in terms of long term market
influence.  All CB's, except the US has a finite supply of dollars.  The
Fed, under its own rules, cannot dump dollars into the market without
raising interest rates, not to mention contradicting the Treasury's
policy of a strong dollar.  When the ECB buys euros with dollars, it is
essentially shrinking the euro denominated economy.  The new euros held
by the ECB must be unloaded to either the Fed or the Bank of Japan who
then must invest or spend it in Euroland.  But if investment
opportunities in Euroland do not improve, then these euros must then be
held in reserve to collect interest, making it difficult for the ECB to
raise interest rates, a move that is needed to fundamentally strengthen
the euro.  The new dollars held by the euro sellers, mostly Euroland
residents and US and Japanese multinationals and exporters, must be
spent or invested in the US or spent on oil which, despite all the
noise, remains only a minor drain in the flow of funds.  Oil money
returns directly to the US anyway.  The unabated appetite for dollar
denominated assets determines the international flow of funds.  Thus the
only condition that will sustain a long-term  rise in the euro's
exchange value is the reduction of euro in circulation in the global
financial markets.  Everyone who finished Econ 101 knows what happens to
an economy when money supply is reduced by fiat - recession.

Summers reiterated his policy that a strong dollar is in America's
national interest.  This intervention, he asserts is merely to cushion
the drastic and excessive fall of the euro, not to pop it up
fundamentally.  The coming vote this week by little Denmark whether to
join Euroland no doubt played a large part in the G7 CB decisions.

Principle aside, the release of 30 million barrels (in 6 releases of 5
million barrels each) in November from the SPR represents merely 8% of
US monthly demand. November crude future fell to day, but only to
$32.68, a $1.32 drop, with an impact of less than 5 cents drop in
gasoline and zero impact on heating oil.  The bottleneck is in US
refining capacity which is already running at 98%.

Conceptually, intervention is deemed an exercise in futility for those
who subscribe to market fundamentalism. Summers had to eat his hat last
week twice: in retreating from his opposition to release from the
Strategic Petroleum Reserve to intervene in oil market prices and to
make concessions in his policy of a strong exchange rate for the dollar.
He explained his turnaround as necessary response to "a rapidly evolving
situation", words that Rudier Dornbush characterized as famous last
words of someone who had just lost his virginity.  Summers is drive the
dollar toward a cliff.  One shoes has already dropped - below
expectation corporate profits; and the market is expecting the other
shoe to drop soon - rising cost from the exaggerated impact of high
dollar denominated oil cost to non-oil producers who export to the US,
which had been keeping US inflation in check.

We now appear to be heading towards a replay of the early 1980s when a
widening trade deficit and a soaring dollar led to a precipitous fall of
the dollar that triggered the 1987 collapse of the equity markets.
Greenspan's strategy of reducing market regulation by substituting it
with crisis intervention is merely swapping the extension of the boom
with increased severity of the bust down the road.  A soft landing does
not do much good when the aircraft has already overshot the runway.

Henry C.K. Liu