Sounding Familiar

Posted February 15, 2009

The US dollar strengthened against most major global currencies except for the yen. The yen rose as investors sold riskier assets when Japan’s GDP was reported to be shrinking at a 12.7% annual pace. A global debate rages about the US stimulus plan and the need for Treasury Secretary Geithner to announce details of bank bailout program.


US President Obama has been jetting around the country building support for the economic stimulus plan even as the world continues to express doubt and concern about its probable success.  Investors are making it clear they are getting impatient with vague talk and generalities.  You would expect a massive $787 billion stimulus plan would lead to an increase in the stock market, but instead the DJIA fell.  For the week it closed lower by 5.2% to 7,850.41 for a 430.18 point loss.

Losses in equity markets were the norm around the world.  And when stock markets in the US go down, the dollar goes up.  The US currency rose against most major global currencies except for the yen.  The US dollar strengthened to $1.277 dollars per euro; to $1.1667 dollars per Swiss franc; and to $1.4238 dollars per UK pound.

The yen, on the other hand, rose against the US dollar as investors sold riskier assets when Japan’s GDP was reported to be shrinking at a 12.7% annual pace.  Of course, Japan is not alone.  The Confederation of British Industry said the UK economy is expected to contract at twice the rate in 2009 than was previously reported. 

The yen rose against the US dollar to 91.61 yen per dollar; strengthened against the euro to 116.99 yen per euro; and increased to 59.68 yen per Australian dollar. 

The UK pound fell to 89.70 pence per euro.

There is a global debate going on right now over whether the proposed US stimulus package will succeed.  Investors are getting weary of the lack of details in the bank bailout plans.  US Treasury Secretary Geithner is getting plenty of criticism for announcing a Treasury plan to assist mortgage foreclosures and to deal with toxic assets without providing specifics.  Even the G-7, meeting the end of last week, is now stepping up the pressure on Geithner to produce some specific plans for assisting the banking industry.

There is general agreement many banks around the world, some quite large, are on the verge of collapse.  But here is the catch.  The Obama stimulus plan and the Geithner TARP spending program have elements that were tried and failed in Japan in 1999.  Back then, Japan entered a recession fueled by easy month that led to excessive spending in the stock and mortgage markets and risky lending by the banks.  (Sound familiar?)

When the banks got into trouble and the stock and mortgage markets went into a nosedive, the government responded with a stimulus package that equated to 1.8 trillion yen.  The government let the banks hide the truth of the toxic asset levels on the balance sheets fearing how investors and consumers would respond.

In a nutshell, the stimulus package was too small and banks were left to deal with toxic assets that were overvalued.  It took six years before Japan began to see a real recovery in the financial sector.  The turnaround did not start until the government required full disclosure of the extent of the toxic asset problem and it took three years to clean up the bank balance sheets.  Over the three years, 19% of the GDP was written off.

The situation which exists in the US and the currently proposed stimulus and TARP programs are almost identical to the Japanese crisis ten years ago.  The big difference is that Japan was able to stimulate the economy by increasing exports to the US.  The US today will not have the good fortune anytime soon of being able to increase exports because this economic crisis is global.

So where does this leave the currency markets?  No one knows.  It was not long ago analysts were predicting the euro and UK pound were headed for parity.  As soon as the prediction was made it had to be revised.  It’s difficult to predict anything right now because of the precarious condition of the global banking system.  It is probably safe to assume the dollar and yen will continue to strengthen against most major currencies as investors seek safe haven assets in a very uncertain world. 

But then again...maybe not.