October 19, 2010 / 7:46 PM / 9 years ago

Analysis: A strong enough dollar in U.S. best interest

WASHINGTON (Reuters) - Treasury Secretary Timothy Geithner seems to be plotting a safe glide path for a dollar that investors widely expect may fall further despite Tuesday’s bounce.

Treasury Secretary Timothy Geithner talks during an event at the Commonwealth Club in Palo Alto, California, October 18, 2010. REUTERS/Kim White

When he broke an eight-month silence on the dollar on Monday, Geithner stressed the need to maintain confidence in the currency, a sharp change from the well-worn Treasury mantra that a strong dollar is in the United States’ best interest.

What Washington needs is a dollar weak enough that exports get a lift to help keep a wobbly economic recovery on track, but not so weak that creditors flee.

“He is pulling the rip cord on one of a series of parachutes for the dollar,” said David Gilmore, a partner at Foreign Exchange Analytics in Essex, Connecticut.

As long as the Federal Reserve is printing money to try to energize the economic recovery, investors will take that as a signal to sell dollars. The Fed is widely expected to announce its next round of asset purchases in November.

The central bank’s so-called quantitative easing “represents the gravitational pull of the earth and there is nothing to prevent the dollar falling,” Gilmore said.

From Washington’s point of view, the Fed’s stimulus is needed medicine not only for the U.S. economy, but for the world at large. If the U.S. recovery goes off the rails, the global economy will suffer as well.

But a dollar crash is in no one’s interest.

That’s where Geithner’s confidence comment comes in. As long as the world has trust in the dollar over the long haul, the United States can avoid some of the unpleasant side effects of a weakening currency — namely high imported inflation and a rush to dump Treasury debt and other dollar-denominated assets.

China’s surprise rate hike on Tuesday, which came just hours after Geithner’s dollar comments, provided an early test of investor confidence.

The dollar, which hit a 10-month low against major currencies on Friday, was up 1.7 pct late Tuesday in New York, its biggest one-day jump in three months, as it drew safe-haven investors worried China’s move would slow global economic growth.

PERFECT TIMING?

The timing of China’s announcement sparked rumors that Beijing and Washington may be nearing some sort of accord on how to realign their currencies before a Group of 20 summit in Seoul, Korea next month.

Higher interest rates in China could pull in more capital and lead to greater upward pressure on the yuan, which Beijing has been allowing to rise slowly.

“I can’t help but conclude that all of these events are connected ... not planned in mutual fashion but indeed representing a real attempt by the U.S. and China to tamp down currency tensions ahead of G20,” Gilmore said. “I call it dollar detente.”

Currency tensions have been building for weeks as the limp dollar drives investment into faster-growing emerging markets. China’s insistence on pegging its yuan currency to the greenback means the euro, yen and emerging market currencies feel the brunt of the dollar’s decline.

Geithner’s insistence on Monday that the United States wouldn’t “devalue its way to prosperity” sounded like a message directed at emerging market allies who have made no secret of their dissatisfaction with the dollar’s decline.

Geithner has pushed for greater G20 involvement in encouraging China to loosen its grip on the tightly managed yuan. His decision on Friday to delay release of a Treasury report that could have accused Beijing of currency manipulation offered another chance for currency diplomacy.

Andrew Busch, foreign exchange strategist with BMO Capital Markets in Chicago, said he expects the G20 to reach some sort of agreement on how to ease currency strains before they hit boiling point, but cautioned against expecting too much.

“I think they’re working on something,” he said. “I’m just not sure if it’s going to produce the results that everyone wants. The G20 is a large group. I’m not sure everyone has the same interests.”

Indeed, some analysts said it was not clear that Beijing would tolerate a faster yuan rise just to help offset the pressures from greater capital inflows.

Lena Komileva, head of G7 market economics at Tullett Prebon in London, said China’s move could signal its intent to tamp down domestic inflation pressures with interest rates rather than with a stronger currency.

“A global currency war — with China aligning with the Fed as the most influential central bank of the world — is a greater risk for high-beta currencies than a hard-landing for China in the near future,” she wrote in a note to clients.

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