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March 10, 1995
Mortgage rates improved this week, and finished in the high eights at zero and zero.
The bond market survived a strong employment report: February Non-Farm Payrolls surged by 318,000 jobs. Bonds are doing well on the following theory: some economic strength means the Fed won't ease soon, and the longer the Fed stays tight, the better the chance of a recession. In a recession, rates fall, and bond investors make a fortune.
Simple, straightforward logic.
This week we have all been hearing more "Dollar Panic!" noise than justified by the facts. In the short run, the dollar decline is not a dangerous problem.
The dollar has had a large fall in value against only two currencies: the d-mark and the yen. Against the pound, krona, kroner, lira, peseta, real, peso, bot, and won, the buck is just fine. Also, against the great currency cop, gold, the dollar is trading right where it has been for more than a year ($385/oz, safely under $400).
However, the relationships between the d-mark, the yen and gold are not where they have been. The d-mark and yen prices of gold have fallen 13% and 10%, respectively, since December. If the price of gold denominated in your currency is falling, you are running a deflationary economy. Not coincidentally, the value of the dollar against the d-mark and yen has fallen 10% and 8.5%, respectively.
The "fall" in the value of the dollar has little to do with the dollar. This last episode has been caused by peculiar economic management in Germany and Japan, each different from the other, but producing similar results.
Germany came out of the 1920's with a permanent fear of inflation. Its "Fed", the Bundesbank, threatens to raise interest rates despite 10% unemployment. Americans, who fear unemployment above all economic calamities, are content with an inflation rate at 3.5%. Germans fear disaster at 2.5%. Low inflation and high rates, and money flows to d-marks.
Japan's economic management is somewhere between perverse and pathological. Japan refuses to reduce its trade surplus, which runs about $100 billion a year. Since Japan won't spend yen, they are mighty scarce, and expensive. An over-valued yen hurts Japanese exports, Japan's overseas investments, and the economies of Japan's trading partners. No matter; Japan cannot stop its surplus compulsion.
The dollar fall could become inconvenient in two events. First, if it results in domestic inflation, the Fed will tighten (no matter what you read in the paper, the Fed will not tighten to protect the dollar). Second, if Mexico has to be re-bailed. Neither would be a disaster.
In the very long run, of course, an uncontrolled Federal budget deficit will shift the dollar to wallpaper status. The "American peso", as grim traders like to say.
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