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Dollar Weakness Inevitable, "They" Say. Hmmm … ?

Tue, Sep 23 2008, 08:15 GMT
by Jack Crooks

Black Swan Capital

It seems the consensus argument is the US dollar MUST go lower given the nationalization of banking institutions and bailouts. But, that hasn’t necessarily been the historical reality. Below is an excerpt from a piece by Stephen Jen & Spyros Andreopoulos of Morgan Stanley:

“Conventional wisdom has it that, as a government fiscalises the contingent liabilities of nationalised banks, the currency of the country in question should depreciate. More generally, banking crises are, very often, accompanied by balance of payments (or currency) crises. The US, being a country with still outsized ‘twin deficits’ (fiscal and external deficits), will likely see the dollar weaken because of the Treasury and the Fed’s decision to effectively nationalise some of the large financial institutions, so the argument goes. An inconvenient fact, however, is that nationalisation of banks, historically, did not tend to lead to further currency weakness. In fact, very often the financial sector and the currency in question reach a trough just as the government takes steps to address the banking crisis. Thus, currency weakness tends to precede, not follow nationalisation.”

Below are some examples cited [our charts added] of banking crisis past and currency impact from Jen and Andreopoulos:

“The S&L Crisis and its bail‐out spanned a protracted period of time. The dollar index did continue to fall from 1986 – the beginning of the S&L Crisis – until 1989 or so. (In 1986, the FSLIC (Federal Savings and Loan Insurance Corporation) – the deposit insurance scheme funded by the thrift industry but guaranteed by the government – first reported being insolvent (incidentally, the main reason why 1986 is remembered as the beginning of the S&L Crisis). The RTC (Resolution Trust Corporation) was established in 1989, and by 2003, the RTC had ‘resolved’ US$394 billion worth of non‐performing assets of US savings and loans. (The total cost of the clean‐up of the US S&L Crisis reached US$153 billion, in ‘current’ terms equivalent to some 2.6% of US GDP in 1991. This translates to US$375 billion in 2008 dollar terms.) The dollar index essentially moved sideways in the early 1990s. The dollar did falter in 1994/95, but that was attributed more to the inflation scare than to the S&L Crisis.”

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Published on  Tue, Sep 23 2008, 08:22 GMT