Issue 22 - December 2, 2004


The Drooping Dollar

As if financial markets have not had enough to contend with this year, the falling
U.S. dollar has now supplanted the elections and oil as the number one market concern. While the dollar has been falling since the summer of 2001, its most recent decline has been accompanied by a chorus of both domestic and international calls for the United States to get serious about its prolific spending.

The Problem

Simply stated, The United States spends more than it takes in. Like any individual who is constantly running too many credit cards at their maximum limits, at some point creditors will say “enough.”

The current situation is defined by two distinct problems – the federal
government’s budget deficit and the national trade deficit. The budget deficit simply reflects overspending by our elected officials, while the trade deficit reflects a much more complex web of manufacturing, export, and consumption habits. It is the combination of the budget and trade deficits that is encouraging investors to avoid U.S. dollar-based assets, thereby driving down the value of the dollar.

Self-Correcting Mechanisms

Traditionally, when countries run up unsustainable deficits, global markets inflict pressure in the form of higher interest rates as a way to encourage more fiscal prudence (think Brazil). But in the past few years in the United States, this has not happened. In fact, the exact opposite has occurred. While the US has spent and consumed, it has been rewarded by even lower interest rates. This has encouraged even more borrowing and spending. Answering why the global markets have aided such an imprudent scheme lies in a discussion of trade

Not Everyone is an Investor – Part I

The low interest rate policy set forth by the Federal Reserve to assist the U.S. in recovering from burst bubbles, a recession and 9/11 has been further subsidized
by a number of factors. The dollar is the dominant currency in the world of trade. Before the introduction of the Euro, 80% of the world’s currency reserves were held in US dollars. Crude oil trades in US dollars. Needless to say, many global players have enormous and real reasons to avoid free market forces being applied to the U.S. dollar. Japan is the single largest player in this discussion. Japan has become an ever increasing buyer of U.S. Treasuries as a means of supporting the dollar. However, Japan is not behaving as a willing investor that thinks that
the U.S. dollar represents great value. Rather, they are resolutely trying to keep their currency from appreciating at a time when their economy is just beginning to emerge from over 10 years of stagnation. Simply put, Japan needs a cheap
Yen to stimulate exports.

Not Everyone is an Investor – Part II

China is a huge emerging global investor. Wal-Mart is China’s eighth largest trading partner, ahead of Great Britain and Russia. This stunning fact also implies China has no reciprocal trade with its eight largest trading partner; it is a one way street.

China’s currency is neither freely tradable nor exchangeable. This implies that
when China takes in Wal-Mart’s dollars they are free to go and invest those
dollars in the best way they see fit. They have dollars for the oil they import and can invest the surplus in Euros or other currencies if they view other markets as more favorable than U.S. alternatives.

Implications for 2005

The biggest implication of our twin deficits and falling dollar is for interest rates. While the Federal Reserve will continue on its course of normalizing short-term
rates to levels which are consistent with the current rate of growth, there is no guarantee the Japanese will continue to invest in U.S. Treasuries which depreciate daily. Absent the current Japanese subsidy, longer term interest rates should retreat to levels which, while not punitive, represent the current reality.

Future declines in the U.S. dollar are certainly possible. However, the Euro-zone will also have to offer compelling reasons to attract investors. The rate environment in the U.S. is currently more attractive than in the E.U. and the E.U. is unlikely to raise rates while their growth is flagging. To say that the currency world is dynamic is certainly to understate the obvious. The lower dollar has been a boon for U.S. corporate earnings and a normalized interest rate environment should set the stage for global investors to take a fresh look at the U.S. in the coming year.

Putting the Euro in Perspective – A Quick History Lesson

The Euro was established by the terms of the 1992 Maastricht Treaty of the
European Union. It was introduced in a non physical form in 1999 at the rate of
$1.18 to the Euro and became legal tender on January 1st, 2002. It reached its low in the summer of 2001 of $0.84 to the Euro and did not return to its issue level until
May of 2003. The current rate of exchange is $1.33 to the Euro. The idea behind a single European currency was to facilitate the ease of trade and economic interactions between EU members who qualified and chose to participate. This uniformity is akin to what we take for granted here in the United States, a
common currency and interest rate policy for all states and regions of the country.


In this Edition

  • Drooping Dollar
  • Not Everyone is an Investor
  • Implications for 2005
  • Putting the Euro in Perspective

Huntington Steele

925 4th Avenue
Suite 3700
Seattle, WA 98104



Past Issues

21 - 11.04.04
Personal Savings
Absence of Rising Tide
US Elections

20 - 10.01.04
Coming or Going?
Speed Limit
Bond Market Showdown
Absence of Context

19 - 09.03.04
Aug '04/ Oil & Jobs/
Cooling of Hot Economy

18 - 08.03.04
July: A Difficult Stage

17 - 07.01.04
2004 Second Half Outlook

16 - 06.01.04
Big Bad Fed

15 -05.04.04
Rising Rates/ Google IPO

14 -04.01.04
First Quarter 2004

13 - 03.02.04
2004: Encore Performance

12 - 02.03.04
Market Outlook/Cell phones

11 - 12.16.03
Auctions - eBay, US Treasury, IPOs

10- 12.02.03
Recent Economic Data
Market Implications

More Past Issues
can be found in our

Newsletter Archive


Market Highlights

  11/30/04 09/30/04 6/30/04 3/31/04 12/31/03 12/31/02
DJIA US 10428 10080.3 10435.5 10357.7 10453.9 8341.63
S&P 500 US 1173.82


1140.84 1126.21 1111.92 879.82
Nasdaq US 2096.81 1896.84 2047.79 1994.22 2003.39 1335.51
EAFE Int'l Equity 1452.59 1318.03 1327.97 1337.07 1288.77 952.65
5 Yr Treasury 3.726 3.408 3.818 2.89 3.231 2.74
5 Yr AAA Muni 2.870 2.61 3.15 2.38 2.45 2.59
10 Yr Treasury 4.387 4.163 4.636 3.874 4.225 3.82
10 Yr AAA Muni 3.660 3.48 4.02 3.49 3.6 3.72
30 Yr Treasury 4.999 4.898 5.166 4.69 5.01 4.77
30 Yr AAA Muni 4.63 4.58 4.93 4.51 4.54 4.69
EUR Currency 1.3267 1.2336 1.2157 1.2227 1.2612 1.0488
JPY Currency 102.99 110.82 108.88


106.92 118.69
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