FX COLUMN-US Treasury Secretaries protest too much?

(Kevin Weir and Jim Cochrane are foreign exchange market (Read more about international currency trading. )
analysts for Reuters. The opinions expressed are their own)

By Kevin Weir and Jim Cochrane

NEW YORK, Oct 27 (BestGrowthStock) – The more things change, the
more they stay the same.

In 1971, U.S. Treasury Secretary John Connally told an
overseas delegation that “the dollar is our currency, and your
problem”. His successor James Baker did him one better,
pursuing a dollar devaluation in 1985.

But times have changed and up until earlier this month “a
strong dollar is in the best interest of the United States” has
been the mantra of Treasury Secretaries ever since.

Over a 13-year period the notion that the United States,
given a choice between a weaker and a stronger dollar, would
invariably choose the latter, was more or less a given.

Jump ahead to 2010 and the Obama administration has tended
to regard the loss of manufacturing jobs as a consequence of an
overly strong dollar, partially explaining the ongoing exchange
rate squabbles with China.

Under the circumstances, Treasury Secretary Timothy
Geithner’s recent — and unusual — reference to the virtues of
a strong dollar drew some attention, as did his remark prior to
last weekend’s G-20 gathering in Korea that major currencies
are “roughly in alignment”.

Although the Treasury continues to deny that the United
States seeks a devalued dollar, it seems reasonably clear that
the revaluation of other currencies would be a welcome, and in
the case of China, a necessary development.

The United States, however, received some not too veiled
criticism during the G-20 gathering, with participants noting
both massive government budget deficits and the likelihood of
further loosening of monetary policy by some central banks.

The dollar’s course over the past 25 years has in fact been
checkered. By April 1995, the dollar index (Read more about the global trade. ) (.DXY: ), measuring
the U.S. dollar against major currencies, had fallen to 80.05,
but by August 1997 it was 26.8 percent higher at 101.48, before
losing another 10.7 pct to 90.57 on October 1998, and then
recovering 33.6 percent to 121.02 by July 2001. On Wednesday of
this week it had fallen another 35.8 percent from its 2001 peak
to 77.70.

If the U.S. pledges not to unilaterally devalue, but the
thrust of its policies is to create a dollar that is weaker
against the currencies of its trading partners, how can
investors take a view that is potentially profitable?

A look at the monthly dollar index (Read more about the global trade. ) chart (=USD: ) reveals
that the U.S. has been the benefactor of strong buying pressure
in a low interest rate environment.

While the monetary policies of the past few years seem
designed to create a weaker dollar, the index has strengthened
7.5 percent since reaching a low of 70.698 on March 17, 2008.
At that time the Fed was in the midst of lowering rates down to
0.5 percent which should have initiated a lagged weakening of
the dollar.

That never happened. Consistent purchases by emerging
market countries, most notably China, helped to keep the dollar
buoyed in an extremely low interest rate environment. That may
change, but how low can the dollar fall if it is allowed to?

The monthly chart has developed a “double-top” or “M”
formation from that low in March 2008 to the present day.
Standard analysis of this type of price action suggests that
the dollar index (Read more about the global trade. ) can fall at least to 59.1.

First it must break convincingly below 74.2. The present
level is 77.6 and the dollar bounced off strong monthly trend
line support at 76.14 on Oct 15th.

A similar study on the U.S. dollar/Japanese yen (JPY=: )
monthly chart shows that a possible bottom is 68.3. Will the
BoJ allow dollar/yen to fall that low? Will China and the other
emerging markets slacken their dollar purchases and allow the
dollar index (Read more about the global trade. ) to reach sub-60 levels? Without their efforts, the
dollar would certainly move lower.

U.S. policies increase the probability for such an
outcome.

FX COLUMN-US Treasury Secretaries protest too much?