Friday, April 22, 2011

Why the dollar lost its groove

THE decline of the once all-conquering greenback gathers pace with few hints that a turnaround in the faltering American currency is near. It is at record lows against the Singapore dollar of around $1.2348.

The US dollar index - a gauge of its performance against major currencies such as the euro, pound, Swiss franc and Japanese yen - has tumbled to 73.949, or near the all-time low of 70.698 that it hit in 2008.


Why the weak dollar?

Record deficits
The US government is projected to run a record US$1.65 trillion (S$2.05 trillion) deficit this year.

Investor Warren Buffett has cautioned that the massive fiscal and monetary stimulus programmes could end up fuelling inflation in coming years and hammer the dollar.

Higher inflation hurts the returns of bond investments that provide a fixed interest income, making them less attractive to investors. In turn, the sluggish demand for US bonds means an even weaker dollar.

Waning confidence
The constant bickering on Capitol Hill between the Democrats and Republicans is undermining confidence that US officials can effectively address the country's indebtedness.

This uncertainty is taking a toll on the US dollar. On Monday, ratings agency Standard & Poor's cited the risks of a lack of a credible plan to reduce the national debt and said the US risks losing its triple-A credit rating.

Easy money policy
In a bid to breathe some life into the economy, the US Federal Reserve has kept its key interest rate between the zero and 0.25 per cent range since December 2008.

The Fed has also embarked on two rounds of quantitative easing. This reduces the cost of borrowing further by putting downward pressure on already rock-bottom rates.

Compelling as it may be, a rate-cutting policy may not always have the desired salutary effect. Japan effectively had near-zero interest rates for years without emerging from its economic downturn.

Moreover, lower rates tend to depress the value of the currency.

'The US is a staggering debtor nation and printing huge amounts of money,' said veteran investor Jim Rogers. 'In my view, the Fed wants to debase the currency.'

Rate hikes
Central banks around the world are raising rates while the US Fed is still staying put. Economic theory suggests that higher rates tend to increase demand for the currency.

For example, the European Central Bank raised its refinancing rate from 1 per cent to 1.25 per cent earlier this month. For several days leading up to the announcement, the euro gained on the dollar as the market priced in the anticipated rate rise.

Many central banks in Asia have also raised rates and are expected to pick up the pace to fight inflation.

Higher risk appetite
Stock market volatility prompted investors across the globe to pull US$24.5 billion out of emerging market equity funds in the first three months of this year, but cash has started flowing back.

Investors are willing to seek risky assets due to strong US corporate earnings and signs the global economy is chugging along even as the Fed stays cautious about when it will start to lift interest rates.

How it impacts you

Consumers and businesses
The value of the US dollar affects everything from the price of imported electronics and clothing to whether a vacation in the US is more affordable for Singaporeans.

For example, if you are a shopper buying food imported from the US, your purchases will be cheaper as the Singapore dollar is now stronger.

Shoppers buying goods online in US dollars also stand to benefit.

Meanwhile, businesses like Apex-Pal International, which runs the Sakae Sushi restaurant chain, have been gaining from the falling dollar.

The company pays for its seafood products in US dollars, but sells its sushi in Singapore dollars.

However, the weaker greenback can also hurt some consumers and businesses.

Commodities like oil are priced in US dollars, so a weaker dollar makes them more attractive to buyers using foreign currencies.

This means that you can expect higher pump prices as well as higher fuel surcharges for air tickets should oil prices continue to surge.

A declining dollar also impacts the competitiveness of exporters to the US.

Investors
A weaker dollar hurts investors holding US stocks but can benefit the holders of Asian stocks.

'The trajectory of the US dollar has implications for Asian equity investors,' says Mr Kelvin Tay, chief investment strategist Singapore for UBS Wealth Management Research.

'Asian equity markets have generally benefited from a depreciating US dollar... Conversely, a strengthening US dollar would be negative for Asia ex-Japan equities.'

Mr Norman Villamin, RBS Coutts' head of investment strategy for Asia, said: 'Singapore investors should still look to their home market for opportunities as we expect the Singapore dollar to be among the strongest currencies in the region looking through year-end.'

gabrielc@sph.com.sg