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US$ carry trade grows, but dollar position firm
14-01-2010
ATI November 2009 Online
LONDON — Much has been said of a dollar carry trade bubble in recent months as the Greenback continues to fall against other currencies, most notably the once-popular carry trade currency — the Japanese yen.
But it is a view not shared by Stephen Jen, arguably one of the world's most reputable currency experts. He was chief currency strategist for Morgan Stanley until May this year, when he left to join BlueGold Capital management, an oil-focussed macro hedge fund.
"I hesitate use that term (carry trade). I don't like that term. It has connotations that people are borrowing in dollars and lending, but the situation is not quite that," he told ATI.
Jen obtained his doctorate in economics from MIT. There, one of his professors was Ben Bernanke, now Chairman of the US Federal Reserve. His doctoral supervisor was the internationally-recognised US economist Paul Krugman.
Jen told ATI that those using US dollars are not borrowing in that currency; rather, they are drawing on real money accounts. "They are just allocating their capital. If they have hundreds of billion of dollars under management, it makes a lot of sense that they allocate capital to emerging markets and Australia, where the economies are growing," he says.
As he sees it, these investors are capitalising on the opportunity cost of heavier weighting in high growth markets. He agrees that the dollar is cheap, and that while the US economy remains weak, there are better opportunities in allocating money more broadly outside the US.
"The dollar is a defensive entity, and if we are going to have a second dip, it makes the dollar that much more attractive because it is a defensive currency," he says. Jen believes that a second dip cannot be ruled out — because the fallout from the first dip has not been allowed to play out fully.
Asked if he believes the weakness in the US dollar will force Asian currencies to appreciate — as is the prevailing argument among some key analysts in Asia — Jen says no-one can dispute that the long-term story for Asia is positive. But he cautions that things can still go wrong. The region faces huge challenges.
The issue is how Asia can re-orientate its economy from export-reliant to being more domestic-focussed. Taiwan, Singapore, Hong Kong and South Korea have long spoken of the need to reduce reliance on exports, but they have not been successful. "Korea is still export-dependent. In the brief period when it was not export-dependent, Korea incurred a credit card crisis," says Jen.
Asian countries have not been that good in switching back to domestic-led growth. Japan, for example has not been successful, and that is the challenge.
"It is still unclear how the next 10 years will pan out," Jen says, adding that he would rather bet that the region will figure a way out. "The currencies will want to strengthen, but their central banks will want to intervene."
The dollar is now trading at a 14-year low against the yen, causing considerable panic among Japanese policymakers, long known for their paranoia about an overly-strong yen and its impact on exports.
As Japanese Finance Minister Hirohisa Fuji talks about the need to take action on "abnormal" currency movements, ominous predictions on the fate of the dollar continue among currency strategists.
Jen believes the rest of the world will continue to have an issue with Asian governments stopping their currencies from appreciating.
He has little confidence that the Group of 20 (G20) has the will to deal with the currency issue — or to strike out with a currency policy. This view is shared by the global currency team of HSBC Bank. In a note, the currency team wrote that the recent G20 meeting concluded without any significant announcement on foreign exchange policies.
Jen says that when it comes to policy, that role remains with G7. He says it is precisely because G20 is more representative of the global economy today that it is also hard to harness diverse opinions there on issues such as currencies. The HSBC team did note that the continued fall in the dollar since March of this year is starting to give the G20 a problem.
The question of the continuing dominance of the US currency and its position as a reserve currency has been raised whenever the dollar is in decline. There is no exception this time around. The HSBC team notes that, in the second quarter, US dollar holdings rose by $US44.5 billion, while Euro holdings jumped US$117.7 billion. HSBC says that the US dollar proportion of total allocated reserves has gradually declined from 71 per cent to 62.8 per cent, while the Euro's share rose from 18.1 per cent to 27.5 per cent in the second quarter.
"I will be the first to say that the dollar is in jeopardy if the US does not tackle some of the fundamental issues facing its economy,” say Jen. “But they are very determined, and they will get it done."
Jen does not question the US dollar’s role as a reserve currency. He says the yen is irrelevant in the world. "The Euro is quite limited in reach. It is used in Eastern Europe, but Russia is still on a dollar standard." He adds that a Euro bill is not recognised either in Asia or Latin America. So it will take a long time to replace the dollar as a benchmark.
Talk of a growing role for the Chinese Yuan does not gel with him either. Despite the number of recent deals between China and trading partners being structured in renminbi, he says this is "more for show than for real". "The renmimbi is not convertible. It is not ready. China won't be ready for 10 years," he says. Jen believes China needs a lot of hard homework on its financial system and capital market to make it happen.
He says open capital would conflict with currency intervention. "Look at Singapore, (which is) such a small market. It has to be on top of its market to guide the currency in certain ways.” “The bottom line is that international trade is done in English. And English is the dollar — the most efficient way for two countries to transact and communicate”, says Jen. |
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