(James Saft is a Reuters columnist. The opinions expressed are his own)
By James Saft
LONDON (Reuters) - The conflict between Russia and Georgia is giving the dollar an old-fashioned boost, based on U.S. stability and military if not economic might.
Armed conflict between Russia and its former and vastly outmatched Soviet neighbor Georgia over South Ossetia has re-awakened investors’ awareness of the safe-haven value of the United States.
And while few are predicting a return to Cold War-style tension, this flight to safety no doubt gave a boost to the dollar’s rally last week as Russian troops rolled through South Ossetia.
The dollar has enjoyed a sustained and sharp rally since a July slump prompted by concern over mortgage giants Fannie Mae and Freddie Mac, rising by as much as six percent against a basket of currencies .DXY.
That recovery was primarily driven by a realization that the rest of the world, Europe specifically, was joining the United States in the economic doldrums.
The sight of Russian forces in action — despite the inevitable and fruitless Western objections — makes holding the currency of a country whose financial system is shaky but which is not currently shelling its neighbors that much more palatable.
“Suddenly the idea of being in a nice, big safe market like the United States is a bit more attractive,” said Simon Derrick, head of foreign exchange strategy at Bank of New York Mellon in London. “People are reassessing where they want their money in this environment.”
Russian shares in the MICEX index .MCX touched their lowest level in almost two years while the rouble tumbled on Monday, prompting intervention in its support by the Russian central bank. But assets recovered later after President Dmitry Medvedev said the conflict may be nearing its end.
Depending on events in the Caucasus the benefit to the dollar could have further to run, but the impact of the conflict on oil will also be important.
Oil mostly ignored the conflict in its early days but rose on Monday as exports from the Caspian region were disrupted. However, even were the conflict to spiral and raise risks of serious and sustained disruptions of exports, it is possible that Europe and the euro would bear the brunt of the impact.
To be clear, markets seem relatively calm about the conflict, perhaps at least in part because its implications are difficult to guess, much less quantify.
Stephen Lewis, economist at Monument Securities in London, sees the euro as first in the firing line if tensions escalate, but draws a different long-term conclusion.
He argues that a significant increase in tensions between Russia and the West might prompt a further escalation of military spending in the United States, bringing with it a wider budget deficit.
“A wider budget deficit might well be associated with a weaker U.S. current account outlook and ultimately with more downward pressure on the U.S. dollar,” he wrote in a note to clients.
Derrick at Bank of New York Mellon found that the dollar generally did pretty well during times of conflict and geopolitical shocks in the period between 1973 and 1993, even at times when U.S. interests and influence could be said to be threatened.
“One simple fact stands out: it was rare for the dollar to lose a significant amount of ground during one of the events. Indeed it is arguable that the only really dollar negative event proved to be the initial fall-out from the Iranian hostage crisis ... and failed rescue,” Derrick wrote in a note to clients.
“Perhaps even more telling was the markets’ reaction to Russia’s invasion of Afghanistan, marking as it did the start of a significant dollar rally.”
The dollar rallied briefly after 52 U.S. diplomats were taken hostage in Tehran in November 1979 but fell over the next month and a half by more than 4.5 percent.
When the Soviet Union invaded Afghanistan just before Christmas in 1979 that decline continued but was reversed sharply in a monumental 11.5 percent rally between early January and April of the following year.
Of course there are very significant differences between now and the latter part of the 20th century, when global conflicts could be viewed in the frame of U.S.- Soviet rivalry. That very likely prompted investors to view conflict as an opportunity to simply buy dollars.
But on the margin, and given that the dollar has a trailing wind, a hot conflict involving Russia, and the prospect of more muscle flexing to come, should support the dollar.
It also has to be said that now is a very good time for there to be a bit of a two-way market in dollar risk, especially from the point of view of U.S. authorities who must oversee a painful economic adjustment and a risky financial system recapitalization, all while continuing to borrow massive amounts of money from the rest of the world.
— At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. email: firstname.lastname@example.org —
Editing by Ruth Pitchford