Semi-Daily Journal Archive

The Blogspot archive of the weblog of J. Bradford DeLong, Professor of Economics and Chair of the PEIS major at U.C. Berkeley, a Research Associate of the National Bureau of Economic Research, and former Deputy Assistant Secretary of the U.S. Treasury.

Friday, December 01, 2006

The Long Run Is Knocking at the Door...

We have been expecting this. We have been expecting this for six years: a substantial fall in the value of the dollar "in the long run." Now the long run is knocking at the door.

Will it continue? And how fast will it proceed if it does?

FT.com / MARKETS / Currencies - Dollar slides further on manufacturing data: Dollar slides further on manufacturing data: By Neil Dennis: A turbulent week for the dollar ended with further sharp falls after manufacturing activity in the US contracted for the first time since April 2003. The dollar plunged as low as $1.9847 against sterling and to $1.3348 against the euro on Friday after the Institute of Supply Management’s manufacturing index fell unexpectedly to 49.5 in November, from 51.2 in October. This signalled that manufacturing activity in the US contracted in November after more than three years of growth.

“The ISM index is likely to be alarming for the Federal Reserve given its dual mandate for both growth and inflation,” said James Knightley, at ING Financial Markets. “If the economy slows in line with the ISM, inflation worries will quickly dissipate with the prospect of rate cuts.” A run of weak US data this week has dogged the greenback, adding to a combination of bearish factors. The weak data has heightened expectations that the Federal Reserve will begin cutting US interest rates. This has led to concerns that high levels of risk, such as carry trades, which had hitherto supported the dollar, could be unwound.

The acceleration of dollar losses has amplified the chorus of central bankers talking about diversifying their reserves into other currencies, such as sterling and the euro. Benign inflation data on Thursday took away another crutch for the dollar, with many traders predicting that sterling would soon rise to more than $2.

The sharp dollar declines began last week as a number of central bankers, including the People’s Bank of China, raised concerns that their huge currency reserves could be at risk from the weak US currency. This reignited fears that central banks might be considering a significant shift away from exposure to the dollar.... “Carry trades are high risk, and even without a narrowing of interest rate differentials they might be unwound if investors start to anticipate greater currency volatility,” said Simon Hayley at Capital Economics. Over the week, the dollar fell by 1.7 per cent against the euro, to $1.3322, and by more than 2 per cent against sterling to $1.9798. The dollar’s fall against the yen, one of the most favoured carry trade funding currencies, was less marked, however, and it ended Friday at Y115.26, down 0.6 per cent on the week...

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