Something we touched on before. This is from
Forex Capital Market [For Ex as in 'FOReign EXchange''
Here's a site of the company profile:
http://www.fxcm.com/company_profile.html http://www.fxcm.com/dollarcrash/
Will the USD crash in 2003?
The U.S has a massive trade deficit that is soaring at an enormous rate and may soon reach 5% of GDP. In the past these large deficits were offset by investment opportunities in the U.S., which attracted a huge inflow of foreign capital and kept the dollar (USD) strong. In 2002 the U.S equities market and bond market did not attract enough foreign capital as a result of the wave of corruption scandals amongst major corporations and accounting firms, and the USD depreciated 15% against the Euro and 10% against the yen. In fact, the widening deficit is becoming so enormous that the U.S. requires $1.9 billion a day in capital inflow in order to offset the dollars that are fleeing the country (to pay for imports). It is when confidence in the United States is shaken, that the dollar suffers. A destabilizing event could create a detrimental shock and cause the USD to crash. Should a USD crash occur, we expect to see significant movement across all of the major currency pairs, providing exciting opportunities for the active trader. Here are three possible scenarios that could cause a USD crash and how a currency trader can profit on the dollar’s demise:
• Scenario 1 – WAR IS OVER CHF, EUR, AUD, NZD, CAD
The US economy entered the war on a weak footing, hoping that a quick success will stimulate the economy. However, economic activity in the US turned sharply worse after the beginning of the war, pointing to the likelihood that the war will not prevent the US from flirting with recession. In addition, unlike the Gulf War, the US will be bearing most of the costs involved in Operation Iraqi Freedom. In 1991, allied countries covered over 85% of the costs for war. This will inevitably come out of taxpayers’ pockets, further hindering consumer consumption. The US also has a huge trade deficit of approximately $500bln, which will require an estimated $1.9bln of capital inflow per day to prevent dollar depreciation. With US consumer confidence at nine year lows as of February 2003, and the slashing of President Bush’s proposed tax cut from $726bln to approximately $350bln, there is no clear economic stimulus that can turn around the US economy.
• Scenario 2 -- EQUITIES MARKET WEAKNESS- EUR, JPY
Trade deficits are bad for the economy when coupled with outflow of private investment from the capital markets. The stock market boom of the 1990’s attracted far more capital into the country than was leaving through the widening trade deficit. During this period, the USD appreciated against most major currencies. In the past year, however, foreign purchases of stocks were down over 24% due to the crash of the tech bubble, corporate scandals, and geopolitical risks. If investors abroad were to decide they no longer wanted to invest in the United States and investors were to pull their money out quickly, the value of the dollar would plunge.
The EUR, as the second largest capital market in the world, will be the primary beneficiary of a weak dollar. In 2002 EUR incurred capital inflows in excess of $110 billion, as compared to capital outflows of $10 billion in 2001, much of which is attributed to USD weakness. The JPY, with a current account surplus representing 3% of their GDP would also benefit from USD weakness. Each time a Japanese export is consumed, dollars are being converted into yen to pay for these exports, which pushes the demand for JPY higher. Amid a shaky U.S. economy, Japanese investors may repatriate their funds from the U.S., thus converting back to their home currency and weakening the capital inflows that have supported the USD. A robust export sector already creates intrinsic strength for the JPY. If the Japanese curb their overseas investments, we expect to see a further appreciation of the Yen. The CHF, which has a trade surplus coupled with a dual-role of being a safe-haven currency is expected to benefit in the same way as the JPY if the U.S. equities market continues to weaken.
• Scenario 3 -- FIXED INCOME (BOND) MARKET WEAKNESS EUR, JPY
Weakness in the fixed income (bond market) will adversely affect the dollar’s value, if foreign investors shift away from US markets. The U.S bond market is a major source of foreign capital inflow. At the end of 2002 foreign investors held over $1,200 billion in US Treasuries, with a significant portion of these assets held be central banks. For the last three years the U.S bond market has enjoyed an enormous bull run, as a result of continuous interest rate cuts. Bonds have an inverse relationship with interest rates, meaning that when interest rates decline, the price of a bond rises (vice versa). If the US economy shows signs of economic recovery, this may lead to a rise of interest rates or the expectation of a rise, which will be priced into the market and cause a drastic fall in bond prices. A fall in bond prices will in turn have a major impact on the price of U.S dollars as foreign investors shift capital out of US bonds. For example, if current long-term rates were to rise from 4% to 5%, long-term bonds would lose 25% of its value.
Currently Japan has a large trade surplus, and is a major source of investor flows into the United States. Should the bond market plummet, further exacerbated by equity market weakness, the market can expect repatriation of funds on a large scale, which will have grave implications for the USD. Another major holder of U.S treasuries are central governments of emerging market countries, that want to hold their reserves in stable economies such as the U.S. The euro will also be a primary beneficiary of portfolio flows. Emerging market central banks do not take long-term views, and will reallocate and shift portfolio flows quickly. In the event of a bond market crash, rather than repatriating funds to the country of origin, it is far more likely that emerging countries would reallocate funds to the Euro zone.
Disclaimer:
Information herein is believed to be reliable, but FXCM does not warrant its completeness or accuracy. Opinions and estimates constitute our judgment and are subject to change without notice. Past performance is not indicative of future results.
Copyright © 2002 Forex Capital Markets. All rights reserved.
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