Critics who worried that QE2 would crush the dollar have been silenced.
Not that we should create glory out of a very bad global situation, but it looks as if Europe’s evolving debt crisis might actually be helping the U.S. Dollar.
It was only last month that world leaders gave U.S. Federal Reserve Chairman Ben Bernanke flak for moving ahead with plans to pump $600 billion into the U.S. economy. While the Fed said another round of so-called “quantitative easing” would give the economy a needed boost, critics argued the move to buy US Treasuries with the freshly printed money would do little but send the greenback into a disastrous downward spiral.
Theoretically, that makes sense: The more dollars in the economy, the less valuable the currency. But from what we’ve seen – at least so far – the critics are wrong.
It’s true the dollar’s value has generally been falling for some time now. This might just be a blip, but the greenback’s gains have been surprisingly good recently. And it seems critics from German Finance Minister Wolfgang Schaeuble, who called the Fed “clueless,” to Japan Prime Minister Naoto Kan, who said the US was pursuing a “weak-dollar policy,” might not have foreseen the depths of Europe’s ongoing debt problems.
In November, the U.S. Dollar Index, which tracks the greenback against six major U.S. trading partners including the euro, yen and pound, rose 5.09%. This was driven partly by rising bond yields and signs of economic recovery that raised the appeal of U.S. assets.
But the most recent gains also had to do with economic uncertainty in Europe. The region’s debt crisis unfolded earlier this year with a bailout in May to prevent Greece from defaulting. Now it looks as if the dominoes might continue to fall as observers watch Portugal, Spain and others closely following the $113 billion bailout package European officials presented to Ireland on Sunday.
Earlier this week, the dollar soared against the euro and other major currencies when a rescue deal for debt-troubled Ireland failed to calm investors worried that the debt crisis might spread. At one point on Monday, a day after European officials announced Ireland’s bailout package, the euro fell below $1.31 for the first time since September 21. The British pound fell to $1.5565 from $1.5602 and the dollar rose to 84.24 Japanese yen from 84.07 yen.
Portugal is widely considered to be most at risk of a bailout given the size of its debts relative to its economy. But the big worry in the market is a possible bailout for Spain, whose economy is about 12% of the eurozone. Most analysts believe Europe is strong enough to handle bailing out Greece, Ireland and Portugal but Spain could be much tougher given the level of debt in its banking system has due in the coming months.
Given the depths of Europe’s troubles, it’s no surprise that the dollar is on a relatively modest winning streak. In times of international turmoil and investor anxiety, the U.S. currency tends to gain as it is viewed as a safety net. What’s more, some economists forecast that the problems in Europe might actually convince global investors and central bankers to rethink the strength of the dollar as the world’s reserve currency.
In fact, Capital Economics economists Julian Jessop and Ben May said in a report days before Europe announced Ireland’s bailout package that “Any worries about the implications of additional QE (quantitative easing) for the value of the dollar will surely be trumped by doubts about whether the euro will exist at all.”
True, as The Financial Times points out, the euro’s fall isn’t as low as when Greece accepted its bailout. The Greek crisis saw the euro tumble in May to $1.20 – far lower than the drops seen during the past few weeks. Nevertheless, Europe’s latest debacle in Ireland has fanned skepticism over the 16-nation euro currency as officials including German Chancellor Angela Merkel vowed it would survive the debt crisis.
The dollar’s rise in the backdrop of Europe’s demise might likely be temporary. After all, the U.S., though probably not to the scale of Ireland and other European countries, has its own debt problems that officials are trying to solve. And some central bankers and even the United Nations have said the greenback’s value has been too volatile to be the world’s primary reserve currency.
For now at least, it looks as if the dollar is seeing better days.
Also on Fortune.com:
The upside of a down dollar
What’s a currency war, anyway?
Why a weak dollar is not strategy for economic growth