What to do about the Falling Dollar (Credit Suisse)

The Dollar Is the First Victim of the Recovery


Joy Bolli, Online Publications Credit Suisse


14.09.2009 Over the last few weeks, stock markets have been performing positively – optimism seems to be back. According to Giles Keating, Head of Credit Suisse Global Economics & Strategy Group, this optimism is based on real facts. However, what is good for the world economy doesn't look to be so good for the dollar.

Joy Bolli: Giles, what's behind all this good news?
Giles Keating: First of all, the economy is recovering more strongly than most people expected – albeit from a very low base: We still have lots of unused capacity and we still have high unemployment, but things are moving in the right direction. Secondly, there is a lot of cash out there. Many investors were left behind given the strength of the early pick-up in the stock market. Now they are wondering if they shouldn't be putting their money to work. And thirdly, the policy makers - central banks, governments - have signaled that they are going to maintain a very expansive economic policy, that they are going to keep interest rates very low for a long time, and that they are going to continue their fiscal spending.


What are the risks going forward?
Clearly, one risk is that this economic recovery won't continue, and some economists are very concerned that things might start to drop off when the current rather strong momentum is over in perhaps two or three months' time. The consensus in the Credit Suisse Economic and Strategy Group is, however, that this risk is not very high. On balance, we think that the recovery will continue, given the expansiveness in monetary and fiscal policies. Another risk is that we could actually see some markets moving ahead too strongly, for example some commodity prices. And that, of course, could create trouble elsewhere.


Does this mean that the next bubble is just around the corner?
I think there is a small risk that there's a bubble around the corner. It's more likely that the problem of a bubble lies perhaps 12 months, 24 months or maybe slightly longer into the future. We do know that the financial markets are very prone to lurch between crash and bubble. The very strong medicine that's currently being administered in terms of very low interest rates is great for getting us out of the slump. But history tells us that it does tend to lead us toward the next bubble. So I think there is a risk, but right now it is more likely that we will see prices tending to move up in a number of areas, though probably not reaching into bubble territory for quite some time.


Amid all this good news, the dollar seems to be in trouble. Just a temporary weakness, or a fundamental problem?
The dollar has seen some big downward movements over the last couple of weeks, and although we think that this won't continue in a straight line, we do think it likely that the dollar will continue to weaken over the next six to twelve months. This can be expected to happen both against the major currencies like the euro and the Swiss franc, as well as against some of the high yielders like the Australian dollar and even some of the emerging market currencies like the Brazilian real. So we are recommending diversification out of the dollar.


What makes the dollar so weak?
Interest rates are, of course, very low in the United States, at almost zero. Although they are low in other countries as well, historically the dollar has needed an interest rate premium - a higher interest rate - than in Europe in order to remain stable or rise in value. Another key reason is that, strangely, as financial conditions get less risky and become more stable, people tend to move out of the dollar. Moreover, a lot of people put money into the dollar during the crisis, and now they have too many dollars. And finally, financial transactions were made by some of the world's major banks at the end of last year since they had to buy dollars in order to square up their balance sheets. That effect is now more or less over. For some banks, this is actually going into reverse, so they are now selling dollars.


Do all investors share this rather pessimistic view of the dollar?
No, of course this is a controversial issue, and I know that many investors, although they recognize the dollar problem, also see problems with other major currencies like the euro. But we believe that there are many financial forces that will boost the euro against the dollar. We would therefore recommend a diversification strategy for those who don't feel entirely confident with the euro. In fact, we consider it a good idea for all investors to diversify broadly into a number of other currencies, as well as – to a lesser extent - into precious metals like gold.

Which industry will surprise us with good news in the next six months?
I think a number of them could, but one in particular that my colleagues and I at Credit Suisse would pick out is the technology sector. We have already begun to see parts of the tech sector move up from very low levels. And as we move forward, there are several very favorable factors here. It's not so much consumer demand, although that could play a bit of a role; rather, it's greater demand from companies that cut back their IT expenditure in a big way during the slump. This, along with some new technologies that are coming through, leads us to think that this sector could perform rather well.


And which commodities will be among the best performers?
We think precious metals can continue to move up. At this current time, gold for example has just broken through the 1000 dollar level, and we think it could certainly head to somewhere around the 1100 level. And some of the other precious metals like platinum could continue higher. We are slightly more cautious about base metals such as copper. We think their inventories have gotten somewhat too high. Regarding oil, some of the bigger countries in OPEC are not keen to see oil get too strong. So we think the trend is up, but perhaps not dramatically so.