Financial Times
January 12, 2011
Currency movements are notoriously difficult to explain, much less predict. Even so, 2010 was an exceptionally tough year. Foreign exchange participants were forced to divine idiosyncratic and conflicting policymaker preferences, to interpret rare events such as Europe’s sovereign debt woes, and to understand obscure policy instruments such as quantitative easing.
The euro/dollar rate, for example, fell from $1.45 to $1.20 in the first half of 2010, only to rise again to over $1.40 in November, before briefly dropping below $1.30 again in its current swoon. Some of this volatility can be ascribed to shifting growth data across the Atlantic. But other less concrete factors, such as Europe’s bogus bank stress tests and investor unease with the Fed’s quantitative easing, seemed to play a larger role. Whenever the favoured market explanation of a big exchange rate movement is “the Chinese are buying”, one has to wonder whether exchange rates have any anchor in long-term macroeconomic fundamentals.
Entering 2011, our currency crystal ball doesn’t seem to be getting any clearer. All the major regions remain trapped in post-crisis macroeconomic strategies that are either inconsistent, incoherent, or both. US budget policy is deliciously contradictory, cutting taxes while promising to balance the budget later, dramatically expanding entitlements while vowing to rein them in later. And because the dollar is so popular, the US is being sure to print lots of them.
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