June 10, 2008 5:17PM

Let’s End the Blame Game, and Intervene

By Alexis Glick

This morning I got hot under the collar about the decline in the U.S. dollar and the need for the U.S. government to step in and help stabilize the currency. I am now of the opinion that we will see a coordinated currency intervention either before the GB meeting in Japan (July 7th or 8th) or immediately after if the dollar does not rally and oil continues to rise or remain at this level.

This morning the bad news in the oil markets continued to make headlines. Look at this from our partners at Dow Jones.

“DEAUVILLE, France (Dow Jones)–The price of oil will approach $250 a barrel in the foreseeable future, said OAO Gazprom (GAZP.RS) Chief Executive Alexei Miller Tuesday.”

Speaking at a conference in Deauville, France, the head of the Russian gas monopoly added that speculative trade flows have had some effect on oil prices, “but this in not critical,” implying that fundamentals of supply and demand are driving the price higher. ”

How about the OPEC President Chakib Khelil who said that the economic crisis in the U.S. dollar and the threats against Iran have contributed in LARGE measure to the rise in oil prices? He said, “If it wasn’t for these factors, the price of oil would probably be $70 a barrel; the depreciation of the dollar alone is adding $40.”

Sabre rattling? Perhaps. Blame game? Yes. Pointing fingers? Absolutely. Why? OPEC is looking greedy and all eyes are on them to do something about increasing production. Will they? Who knows! Saudia Arabia didn’t do much when the president traveled to meet King Abdullah. Now they’re suggesting an earlier OPEC meeting to address speculation and supply/demand inbalances. Why? Could they be feeling the heat? Or is it our fault as the OPEC President suggests?

I believe something is brewing in D.C. and it has INTERVENTION written all over it. If the Fed, the ECB and the BOE can reliquify the markets as they did several months ago on a coordinated effort as the credit crisis peaked, why wouldn’t they consider a coordinated effort to prop up the U.S. dollar? If your China, one of the biggest holders of U.S. Treasuries and have record levels of inflation due in some measure to the dollars peg to oil, wouldn’t you want some answers? Some movement? Some improvement in the currency that you are holding trillions of dollars of?

If you are the President of this country and you know as your political advisers are telling you that the Fed cannot do anything at the moment and will be scrutinized if they raise rates too early, wouldn’t you want solutions, options? What options do you, we, have to turn this picture around? We cannot aggressively go buy the U.S. dollar and blatantly punish the only thing that is working in this economy: exports. On the other hand, we can signal to everyone else as I believe we are, that a stronger dollar is in the interest of EVERYONE. Think GLOBAL!!!

If you are the President and thinking about legacy and an economy that is the worst in the eight years that you occupied the office and you want to give the new Republican nominee John McCain a fighting chance, wouldn’t you consider this option. You boost the U.S. dollar, cut the legs out of oil, put a 2nd half recovery into effect and the market will rally BIG TIME. The G8 announces a coordinated move and this market is OFF TO THE RACES. You’ve read my old blogs. The market is lacking a catalyst! A coordination would be a HUGE catalyst and a sign that the Global Economy is prepared to fight inflation by supporting the currency that helped this Global Economy become what it is today.

How many Central Banks have U.S. dollars in their banks?

Am I driving you to drink? My friends tell me that the news, the headlines about the U.S. Economy are depressing them. They worry as I do, that the fear will become a self-fulfilling prophecy. My thesis above may very well be nuts. Perhaps I’m trying to find that catalyst that will calm the fears and bring us some hope. I have always said that I prefer to look at the glass half full versus the glass half empty.

Look at China today. My fx expert and friend Kathy Lien from the DailyFX.com who I barage with currency questions noted this. “They, China, urged the US to stabilize the dollar this morning / last night. The Ambassador argued that the weaker dollar has fueled inflationary pressures and is reducing the value of the FX reserves. With 1/3 of its entire annual GDP is in U.S. assets now, they also want the dollar to stop falling.” You see if the U.S. Government keeps getting this message they’ll look like geniuses when they announce a coordinated move.

I asked Kathy what the precedent is for past interventions and how they have worked. Take a look at her e-mail back to me.

As for your Q, Hope this is not too much info!

Intervention has happened a number of times by different central banks. The most recent bouts of intervention have been by the Reserve Bank of New Zealand last year and the Bank of Japan who last stepped in in 2004. Washington on the other hand has mostly engaged in verbal intervention instead of physical intervention. The most notable was in Q4 2004 when several Fed speakers argued that the US current account deficit required a weaker USD.

Actual intervention is usually coordinated with other G7 countries given the importance of the USD in financial markets. In 1985 the G7 agreed at the Plaza Hotel in New York to push the USD down through intervention and by Germany and Japan reflating their economies to help reduce America’s current account deficit. In 1987 the Louvre Accord resolved to support the falling USD. Coordinated G7 intervention to support the USD in 1995 helped start its long bull run for the rest of the decade.

Since 2000 the US has maintained its strong USD rhetoric but at the same time has pushed China unilaterally to revalue its currency and for the G7 countries to lobby for greater currency flexibility in Asia. The September 2003 G7 meeting in Dubai first called for such flexibility resulting in the USD weakening sharply. Similarly, the USD fell again in April 2006 when the G7 hardened its language on Asian exchange rates.
The G7 meetings for now remain the main venue for the US Treasury to reiterate its exchange rate policy.

How is it done?

Intervention is typically done by using a government’s holdings of foreign exchange reserves to buy currencies outright. There are 2 types of intervention. Sterilized and unsterilized. Sterilized intervention involves occurs when a central bank counters direct intervention in FX with a simultaneous offsetting transaction in the domestic bond market.
Sterilized intervention is less effective than unsterilized intervention.

Effectiveness of Intervention

However, the effectiveness of currency intervention as a policy tool has been an ongoing debate within the financial markets and academia for years. In a speech given by Greenspan in 1999, he was quoted as saying that it is difficult to determine the effectiveness of currency intervention because that would involve developing a successful model of exchange rate determination, and a clear understanding of the influence of sterilized intervention (requires offsetting intervention with buying/selling of govt bonds), both of which have been difficult for the economics profession. In addition, in order to quantify the effectiveness of intervention, traders will need to be able to determine what the exchange rate would be in the absence of intervention, which is not easy to calculate. Ultimately, the market does agree that FX intervention has short-term effects on controlling undesirable FX moves, but the long-lasting effects is more uncertain.

Kindest regards,

Kathy Lien
Chief Strategist
DailyFX.com

This is a more concise summary of past coordinated action:

1) September 1985 - G7 Plaza Accord initiated action to weaken the USD
2) February 1987 - G7 Louvre Accord led to support for the USD
3) April 1995 G7 finance ministers in Washington agreed to support the USD
4) Summer of 1998 US and Japan both intervened to support the JPY
5) September 2000 - ECB persuaded the Fed and the Central Banks of Japan, England and Canada to intervene to help the EUR.
6) September 2003 - At the G7 Dubai Meeting, the group called for currency flexibility, leading to sharp USD weakness
7) April 2006 - G7 hardened its language on Asian exchange rates leading to USD weakness