G7 Group Ignores Weak U.S. Dollar

by: Ralph Shell

The G7 meeting ended with no announcement from the participants of any program or dialogue to contain the dollar's weakness. The markets seemed to be disappointed and initially the dollar started weaker against most currencies. After spiking up to 1.4655, the pair has sold off to 1.4595 and has since recovered to 1.4620.

Perhaps the weaker dollar will serve to gradually reduce the US trade deficit. Friday we get the US trade balance report, and it is anticipated to be a 32.7B deficit. If the US consumer is really going to increase his savings and reduce spending, the trade part of the twin deficit should come down. A poor trade figure might signal the dollar needs to depreciate some more.

This week the US Treasury is auctioning off 78B in debt. It starts Monday with 7B of 10 year TIPS, followed by 39B 3 year notes, 20B of 10 year paper, and finally 12B of 30 year bonds. Compared to recent auctions, this one is much smaller, but it does contain large amounts of the 10 and 30 year bonds, and takes the total over 1.6T for the year.

As David Goldman points out in a recent article in the Asia Times, thanks to the easy money policy of the US Gov, the banks borrow short at next to nothing, and use this money to buy Treasuries. So the increased liquidity finances the government spending, the private sector funds diminish, and the economy shrivels. Japan experienced the same problem in the early 1990s, but they revived their economy with exports, something the US seems incapable of doing.

There is another problem with this plan. The morgue is filled with bankrupt companies that would borrow short and lend long. If the foreign buyers, who have bought 43% of this years 1.5T of Treasury issues reduce their purchases, then rates will go up and we have a new crises. Short rates would go up, the yield curve would tighten. These same lending institutions with short term borrowing requirements would be squeezed, perhaps to the extent that they will become insolvent. There is going to be some unintended consequences with today's easy money policies.

These may be long term issues but the Euro is climbing back above 1.4640.

We have been surprised that the spike high of the Euro at 1.4844 has remained unchallenged. Try the long side on a pull back to 1.4575 with the appropriate money management stop, and see what happens later this week.