Dollar Set For Longest Decline Since Louvre Accord

(Bloomberg) -- The dollar is set for the longest annual losing streak since 1987, when Group of Seven finance ministers met in Paris to end a three-year slide in the currency.
The Federal Reserve's Trade-Weighted Major Currency Dollar Index has retreated 6.2 percent this year after dropping in the previous two. The index began a three-year drop in 1985, when G-7 ministers met at the Plaza Hotel in New York and agreed a weaker dollar was ``desirable.'' The group met at the Louvre in 1987 and decided a further drop ``could damage'' world growth.
The dollar is being buffeted by record current account and fiscal deficits, less appetite among foreign investors for U.S. assets and comments from Federal Reserve and Treasury officials suggesting they favor a weaker dollar, said James McCormick, head of currency strategy at Lehman Brothers Holdings Inc. The dollar is near a record low versus the euro after rallying earlier this year as the Fed prepared to increase interest rates.
``The real lesson is to listen to policy makers and the U.S. is saying that they're comfortable as long as the dollar weakens in an orderly way,'' said McCormick, who is based in London. ``Unless you see a meaningful change in fiscal policy in the U.S. or a meaningful turn in the current account, the dollar will continue to go down.''
Lehman, the most accurate overall forecaster of exchange rates last quarter, predicts the dollar will weaken to 90 yen and $1.40 per euro within 12 months. The dollar traded at 103.09 yen and $1.3626 per euro at 11:08 a.m. in New York, according to electronic trading system EBS.
`People Listen'
The dollar is down 15.7 percent from its high for the year of $1.1761, reached in April. Had the currency remained at those levels, the dollar would have gained 6.6 percent this year. The Fed's index dropped to a nine-year low of 79.47 on Dec. 27.
More than half of the dollar's 7.5 percent slide against the euro this year followed remarks by Fed Chairman Alan Greenspan to the European Banking Congress in Frankfurt on Nov. 19. Foreign investors will eventually tire of funding the current account gap and may channel money into other currencies, Greenspan said. The U.S. Treasury sets dollar policy.
``For Greenspan to talk about the U.S. dollar is rather unusual -- that is typically done by the Treasury,'' said Rick Arney, foreign-exchange strategist in San Francisco at Barclays Global Investors, which manages more than $1 trillion. ``When he talks, people listen.''
`Exploding'
The current account is a measure of trade, services, tourism and investments. The shortfall widened to $164.7 billion last quarter, equivalent to 5.6 percent of gross domestic product, the Commerce Department said on Dec. 16. Net purchases of U.S. assets slowed to $48.1 billion in October, the smallest increase in a year, the Treasury said a day earlier.
``The main thing we're seeing with the dollar is that the current account deficit is exploding and that it has to unwind,'' Kenneth Rogoff, former chief economist at the International Monetary Fund and now a professor of economics at Harvard University, said in a telephone interview from Washington.
Impact on Profits
As the dollar weakens, it's boosting income from overseas for U.S. companies from Boston-based Gillette Co. to Amazon.com. Inc. in Seattle. Adam Aron, chief executive officer of Vail Resorts Inc., said in an interview in New York on Dec. 17 that the dollar's drop is drawing more foreign tourists to his hotels and stopping some Americans from skiing in Canada, against whose currency the dollar has lost 6.6 percent this year.
``Frankly, the weak dollar is very good for real estate,'' Donald Trump, chairman and chief executive of Trump Hotels and Casino Resorts Inc., said an interview in New York on Dec. 2. ``People are flocking to New York, buying apartments in New York. Every job I have is selling out almost immediately.''
DaimlerChrysler AG is among European firms to say the dollar's drop is hurting. Thomas Weber, a member of the car maker's management board, told reporters in Frankfurt on Nov. 25 that the dollar's decline will reduce profit at the Mercedes Car Group, which contributed about half of 2003's operating profit. Italian business optimism fell to a nine-month low in December as a stronger euro made manufacturers pessimistic about exports.
ECB's Record
German Chancellor Gerhard Schroeder said in an interview with the Handelsblatt newspaper that swings in the value of the euro are a cause for concern. The interview was published today.
The European Central Bank hasn't sold its currency since the euro made its debut in 1999. The euro's gain isn't ``too troublesome,'' Guy Quaden, who votes on interest rate policy at the ECB, said in an interview with Belgian magazine Tendances published on Dec. 23. Quaden is head of Belgium's central bank.
ECB President Jean-Claude Trichet said on Dec. 15 at a press conference in Frankfurt that ``recent moves'' in the exchange rate ``are unwelcome.'' The euro has gained more than 2 cents since then.
Currency sales from Japan are ``much more likely than from Europe,'' said Barclays's Arney. ``Europe lacks the credibility and consistency that Japan has in their policy proclamations.''
Japan sold a record 32.9 trillion yen ($317 billion) in the fiscal year ended March 31 to stem the pace of an advance the government said was driven by speculators. It hasn't touched the exchange rate since, Ministry of Finance figures released today show.
Bush Alone
George W. Bush is the only U.S. president not to have bought or sold dollars since the collapse of the Bretton Woods system of fixed exchange rates more than three decades ago. As part of that arrangement, the dollar was fully convertible into gold at a rate of $35 per ounce and other countries fixed their currencies to the dollar.
The Fed's trade-weighted index, which began in 1973, has lost 27.9 percent since the start of 2002, the most since it dropped 34.7 percent between 1985 and 1987. The euro accounts for 34 percent of the index, the Canadian dollar makes up 30 percent and the yen has 20 percent. Other currencies in the basket include the British pound and the Australian dollar.
U.K. Chancellor of the Exchequer Gordon Brown, who will chair meetings of G-7 finance ministers and central bankers next year, said discussions will be devoted to ending regulations that stifle growth and tackling budget deficits rather than trying to thrash out agreements to steer currency markets.
``When we hold discussions, they will not be over a Louvre or Plaza accord,'' Brown told the British parliament on Dec. 16. ``The fact of the matter is that exchange rates over time will reflect the fundamentals of the economy.''
The G-7 comprises the U.S., Germany, Japan, France, Britain, Italy and Canada.
European Economy
Stagnation in the euro region's economy may spur the start of a recovery in the dollar from the middle of next year, said Larry Brickman, a currency strategist in New York at Bank of America Corp. ``It will start with Europe, when people see the pain a stronger euro is causing their economy.''
The economy of the 12 nations sharing the euro expanded 0.3 percent in the third quarter, the slowest pace in more than a year. Manufacturers' confidence in France fell for a second month in December on concern the euro's appreciation will erode demand for the country's exports.
Bank of America predicts the dollar will retreat to $1.40 per euro in the first quarter and 100 yen before recovering to end the third quarter at $1.25 and 105 yen.
Some investors may also buy the dollar should the Federal Reserve accelerate the pace of rate increases, said Jim O'Neill head of global economic research at Goldman Sachs Group Inc. in London.
Fed policy makers lifted their target interest rate for overnight loans between banks to 2.25 percent on Dec. 14, the fifth increase this year, and said they will keep doing so at a ``measured'' pace.
`Remain Bears'
This month's increase pushed the Fed's rate higher than the ECB's for the first time since 2001. The ECB's benchmark rate is 2 percent. The U.S. central bank's target remains below the Bank of England's rate of 4.75 percent, the Bank of Canada's 2.5 percent and the Reserve Bank of Australia's 5.25 percent benchmark rate.
``We remain bears because of the current-account deficit,'' said O'Neill. ``For the dollar to really, really stabilize you'd have to see the deficit go down to about 3 percent of gross domestic product.'' The third-quarter deficit is equivalent to 5.6 percent of the nation's $11.8 trillion economy.
Goldman estimates the dollar will trade at $1.40 per euro in 12 months and 95 yen.

To contact the reporter on this story:
Joshua Krongold in New York at jkrongold2@bloomberg.net.

Tsunami Adds To Asia's $413 Billion Natural Damage

(Bloomberg) -- The havoc wreaked by Sunday's magnitude 9 earthquake and the 33-feet-high tsunamis it unleashed ought to serve as a grim reminder to investors of Asia's vulnerability to nature's wrath.
Just how prone is Asia to natural calamities? For an answer, see the International Disaster Database, available at the Web site: http://www.em-dat.net/disasters/statisti.htm
The database, maintained by the Brussels-based Université Catholique de Louvain's Centre for Research on the Epidemiology of Disasters, shows that between 1970 and last year, droughts, quakes, epidemics, extreme temperature, famines, floods, insect infestations, landslides, volcanic eruptions, waves, wildfires and storms caused damage worth $413 billion in Asia.
That's a staggering loss, considering the figure is higher than the combined gross domestic product last year of Hong Kong, Thailand and Malaysia. The total damage caused by natural disasters in the same 34-year period was $213 billion in North America, almost half the Asian level. In the European Union, the cost of calamities added up to less than $141 billion.
Floods in China and earthquakes in Japan have been the worst culprits, accounting for almost half the damage in the region since 1970. An exceptionally bad year was 1995, when a quake leveled much of the western Japanese port city of Kobe, costing Asia's biggest economy an estimated $95 billion.
The Kobe temblor collapsed elevated expressways and destroyed bullet train bridges. The financial markets kept feeling the tremors until much later. In August 1995, seven months after the quake, Kobe-based Hyogo Bank Ltd. failed after many of its clients went out of business.
Bigger Than Kobe?
Will the latest tragedy, which has dwarfed the Kobe disaster in terms of human lives lost, also overshadow it financially? Will there be a long-drawn crisis of investor and consumer confidence in Asia? The answers aren't clear-cut.
Owing to the geographical spread of Sunday's calamity, it's difficult to gauge the extent of damage to individual economies from the waves that flooded coastal towns in India and Sri Lanka and tourist resorts in Thailand, Malaysia and the Maldives.
Much of the panic is concentrated, at least for now, in the tourism industry, which could rebound in no time. Unlike in Indonesia, where lingering security concerns following the Oct. 2002 Bali bombing kept foreign tourists away for an entire year, holidaymakers may return fairly quickly to Phuket and other Thai resort islands once newspapers lose interest in the tragedy.
Limited Impact
``The economic impact from the earthquake and waves will be quite limited,'' says Chua Hak Bin, an economist at DBS Group Holdings Ltd., Singapore's biggest bank by assets, ``as it destroyed mainly tourist areas and coastal towns, not major cities or key infrastructure. The Kobe earthquake had a far greater impact in terms of capital destruction.''
The death toll from Sunday's earthquake off the Indonesian island of Sumatra has raced past 23,000, and is still climbing. In Sri Lanka alone, 500,000 people may have lost their homes. By comparison, the Kobe temblor killed an estimated 6,400.
The recent tragedy differs from the destruction of Kobe in another important aspect: The ability of the Japanese government to rebuild the city was never in doubt, though one can't say the same of the Sri Lankan government, which has only just begun to repair a nation almost torn asunder by 20 years of civil war.
Double Whammy
Elsewhere in Asia, if economic growth stays on course -- as it should if the region's central banks continue to maintain low interest rates -- higher tax collections may ameliorate some of the fiscal pressure.
Sri Lanka faces a double whammy: It's the worst-hit by Sunday's catastrophe and the most ill-prepared to deal with it without outside help. The Sri Lankan government's widening budget deficit may severely limit its ability to revive the coastal economy -- especially fish exports -- from what Lalith Weeratunga, secretary to the prime minister of Sri Lanka, calls ``absolute devastation.''
That underscores the importance of fiscal far-sightedness in Asia. A raw deal from nature may be the region's inexorable fate, though with prudent budgeting in good years, Asian governments can marshal resources for terrible times like these.

To contact the writer of this column:
Andy Mukherjee in Singapore at amukherjee@bloomberg.net.

Washington Fiddling While Private Retirement Burns

(Bloomberg) -- Why has fixing Social Security become the epicenter of the U.S. retirement debate while the easily bolstered private retirement system is largely ignored?
Social Security generously provides inflation indexing of benefits, which the private system largely lacks. Worse yet, the private accounts that the Bush administration wants will most likely balloon the U.S. budget deficit, raise interest rates and do nothing to solve Social Security's long-term funding shortfall.
Yet in an era in which inadequate 401(k)-type plans are the dominant employer retirement program -- plans that you already can own and manage yourself -- Social Security may be getting a needless shock treatment.
``Social Security provides almost universal coverage,'' says Zvi Bodie, an economics professor at Boston University and an authority on pensions, ``but (private) defined contribution and defined benefit plans combined only cover half of the workforce.''
There's no reason why the private sector can't duplicate inflation protection within existing retirement plans without dismembering Social Security. Policy makers, though, are pursuing the wrong beast.
401(k)s Fall Short
Privatization may eliminate some of Social Security's insured guarantees, leading to dire consequences. The lack of inflation protection would erode monthly benefits, which wouldn't keep pace with the cost of living in retirement.
In contrast, 401(k) programs, which are offered by most large-and medium-sized employers, don't offer any guaranteed monthly payments, cost-of-living increases or survivorship insurance. Few employees fully fund them and up to half of employees changing jobs cash in the plans' lump sums.
Bodie, who is also chief knowledge officer of New York-based Integrated Finance Ltd., which was co-founded by Nobel Prize winner Robert Merton, says insurers and employers can team up to offer insured, inflation-indexed annuities within 401(k)-type plans that offer ``risk-free retirement income.'' His company is pioneering such a product that he says will be offered by a major employer soon. Any financial service concern can offer such a product now, but there are few, if any incentives in U.S. laws to do so.
The Right Context
There's little debate that Social Security will be facing a funding shortfall in 2018, when it will be paying out more in benefits than tax dollars received.
Sounder fiscal remedies may consist of letting state and federal workers into the system and increasing the payroll tax contribution limit or retirement age.
Further muddling the central argument on how to fix Social Security is how so-called reformers have cast the privatization program: A pension plan that you should own.
Social Security is a meager anti-poverty safety net that covers 96 percent of the U.S. workforce with an average $18,324 a year benefit for retired workers with spouses (aged 62 and over), $22,584 for widowed parents (with two children) and nearly $10,000 a year for children of deceased workers, the Social Security Administration estimates.
As a multi-benefit social insurance policy, the program also provides guaranteed disability and survivorship benefits, a package unmatched in the private sector.
Benefits Aren't Enough
Defined-benefit or traditional pensions are the closest thing to Social Security in terms of guaranteed retirement income sources. Unfortunately, federally insured DB pensions are going the way of typewriters.
There were 114,000 such pensions in 1986 and about 30,000 now, according to the Pension Benefit Guaranty Agency, a quasi- public entity that insures the plans.
These expensive-to-run and often badly managed old-style pensions have been toxic to employers, who have been dumping them en masse.
IBM, for example, recently said that it will offer 401(k) plans to employees hired after Jan. 1, replacing a defined benefit plan.
Employers Backing Away
Over the last quarter century, employers have not only sponsored fewer traditional pensions, their total contributions have become much stingier.
When 401(k)s were born in 1978, only 11 percent of total contributions in both plans were made by employees. By 1999, workers were investing 70 percent of the money in 401(k)-type plans and 51 percent into defined benefit programs, according to the U.S. Department of Labor.
Unless defined-benefit costs and rules can be streamlined to appeal to more employers, they will continue to be seen as albatrosses by companies. Almost 200 plans were absorbed by the pension agency in fiscal 2004, up from 155 the previous year.
Massive terminations of defined-benefit offerings have forced the pension agency to pay benefits to more than 1 million workers. The agency posted a $23 billion deficit in fiscal 2004 and is faced with $63 billion in pension liabilities.
With several airlines and manufacturers seeking to walk away from their defined-benefit obligations -- shifting even more pension debts to the pension agency -- the shortfall at the agency is only likely to get worse. A taxpayer bailout may be necessary.
Change is Possible
Want to improve your retirement funding no matter what happens in Congress? Lobby your employer to provide low-cost (less than 0.50 percent in total annual expenses) fixed selections in your 401(k).
These products, called ``lifestyle,'' ``separate accounts'' or ``target'' funds, tailor a mix of stock and bond funds to your age and risk tolerance.
If self-employed, a professional or sole proprietor, you can also establish your own defined benefit plan and contribute $165,000 this year. They are becoming easier and less costly to set up.
None of the existing programs will work without some tweaking and your understanding how to fully fund them. If stymied by the blizzard of retirement information in your workplace, ask your employer to provide the services of certified financial planners who have no connection to the funds in your 401(k).
You can also seek objective advice on your own. It's a far more productive approach than waiting out the fate of Social Security in the coming year.

To contact the writer of this column:
John F. Wasik in Chicago at jwasik@bloomberg.net.

Cheap Money Trumps Sea Of Negatives For Bonds

(Bloomberg) -- If you had told a roomful of bond traders one year ago that the dollar would plummet, commodities would soar and inflation would rise in 2004, not one of them would have predicted that the 10-year Treasury note yield would end the year within a hair's breadth of where it began it, at 4.25 percent.
As analysts at Bridgewater Associates Inc. put it in a note to clients earlier this week: ``Economic growth went up, bond yields went down. Short rates went up, bond yields went down. Inflation went up, bond yields went down.''
They could have thrown the burgeoning budget and trade deficits in with the list of things that went up that heretofore would have sent bond prices down.
The bond market's stoicism in the face of adversity is unprecedented, not to mention a sore spot for traders who saw low yields -- artificially depressed by Asian central bank buying -- as an opportunity to sell bonds short in anticipation of a decline in price.
Money managers polled weekly by Stone & McCarthy Research Associates of Princeton, New Jersey, have been defensive all year, reducing their exposure to a rise in interest rates relative to their benchmark index. The average portfolio duration, a measure of risk, fell to an 11 1/2-year low last June before creeping higher.
In other words, money managers positioned themselves for an aggressive rise in rates just when yields were cresting.
Ignoring Inflation
And who can blame them? This is the first time long-term yields started their descent before the Federal Reserve raised overnight rates at the outset of a tightening cycle. Usually it's toward the end of the cycle that long rates break ranks with short rates as monetary policy starts to bite.
When one considers that the inflation risks are skewed to the upside, a 10-year note yield near 4 percent is puzzling. Even discounting the surge in oil prices that has boosted the year- over-year increase in the consumer price index to 3.5 percent in November, the core CPI, which excludes food and energy, is accelerating, any which way you look at it.
The core CPI rose 2.2 percent in the year ended November, double the increase of a year ago. The index rose an annualized 2.7 percent in the past three months.
Core services have shown little variation over the past two years, rising 2.5 percent to 3 percent. The shift has come in core goods prices, which fell 2.6 percent in the year ended November 2003 compared with a 0.5 percent increase in the past 12 months.
Weak Dollar
With non-oil import prices rising at the fastest pace in nine years -- up 3.4 percent in the past 12 months -- and the dollar's recent weakness not yet fully reflected in imports, the Treasury market's complacency is remarkable.
``Treasuries appear vulnerable to a restoration of above- trend growth,'' Citigroup Inc. economists write in their 2005 outlook, ``Prospects for Financial Markets.''
Those vulnerabilities were noted last year as well. Economists surveyed a year ago by Bloomberg News expected an average 10-year yield of 5.1 percent in December 2004.
That didn't work out so well, so they put their money back on the same number for the next spin of the wheel.
Asian Central Banks
What happened to the higher expected yields that weren't? One frequent answer is massive Asian central bank buying of Treasuries from countries that intervene in the foreign-exchange market to prevent their currencies from rising (Japan) or that acquire dollars from exporters who can't convert them in the open market (China).
While China grabs all the headlines, as of October Japan held $715 billion of U.S. Treasuries, a 40 percent increase from a year earlier. (The Treasury statistics on foreign holdings include both official and private investors.) China, whose trade surplus with the U.S. ballooned to $131 billion in the first 10 months of the year, increased its holdings by 16 percent to $174.6 billion.
The hole in that argument is that foreign central banks traditionally park their dollars in the short end of the yield curve, according to Jim Bianco, president of Bianco Research in Chicago.
Short rates, which key off expectations for Fed policy, have risen this year. The yield on the two-year Treasury note is up 120 basis points this year, rising almost tick for tick with the 125 basis-point increase in the fed funds rate. A basis point is 0.01 percentage point.
Long rates remain oblivious.
Hedge Fund Fandango
``Don't make the mistake of confusing bonds with GDP futures,'' Bianco says. ``Financing rates are more important to bonds than the inflation rate.''
Easy money since the Sept. 11, 2001, terrorist attacks has encouraged ``a new breed of leveraged investor, with most of the hedge-fund growth coming in fixed-income arbitrage or relative value funds,'' Bianco says, based on data from Hedge Fund Research in Chicago.
The growth in hedge funds is also evident from the explosion of trading in U.S. stocks and bonds from the tax-haven countries of the Caribbean, where total turnover is up 100 percent in the past year, according to Bianco.
If cheap money has been the inducement for hedge funds to load up on 10-year notes, then higher real rates should be the trade's undoing. With core CPI up almost as much as the funds rate this year, there's been no change in the real cost of financing bond purchases so far.
Cheap money has been an incentive for more than leveraged trading.
``It was a big employment incentive, too,'' Bianco says. ``For hedge funds.''

To contact the writer of this column:
Caroline Baum in New York at cabaum@bloomberg.net.

U.S. 10-Year Note Fell This Week As Dollar Declines, Durable Orders Rose

(Bloomberg) -- The U.S. 10-year Treasury note fell this week in New York as a drop in the dollar to a record against the euro spurred speculation foreign demand for Treasuries and other U.S. financial assets will dim.
The note has fallen in eight of the past nine weeks. A weaker dollar can erode returns on U.S. securities for international investors. The Bond Market Association, an industry trade group, recommended no trading in U.S. bond markets today in observance of the Christmas holiday.
``Continued declines in the dollar will be unsettling to foreign holders of Treasuries, so we could see a minor exodus from Treasuries,'' said John Nyhoff, chief economist at Tokyo- Mitsubishi Futures Inc. in Chicago.
The benchmark 4 1/4 percent Treasury note due in November 2014 fell about 1/4, or $2.50 per $1,000 in face value, to 100 9/32 this week in New York, according to bond broker Cantor Fitzgerald LP. The note's yield rose 3 basis points, or 0.03 percentage point, to about 4.21 percent. The yield is up from a six-week low of 4.07 percent reached on Dec. 16.
The dollar is set to wrap up a third straight losing year against the euro, having declined 34 percent since the start of 2002. Today, it fell as low as $1.3548 per euro, the weakest since the 12-nation European currency's 1999 debut.
Reports this week suggested the economy is growing enough to keep Federal Reserve on a continued pace of lifting interest rates. The Fed raised its benchmark rate five times since June, to 2.25 percent. Durable goods orders rose last month, personal spending and income increased and consumer confidence reached an 11-month high. Faster growth may lead investors to favor stocks and other higher-return assets over Treasuries.
`Risk'
``The economy is growing at a fairly solid clip; the Fed should continue to remove accommodation,'' meaning it will keep raising rates, said Laurence Meyer, president of St. Louis-based Meyer's Monetary Policy Insights and a Fed governor from 1996 to 2002. ``There's upside risk for long-term rates in 2005.''
International investors increased their holdings of U.S. assets in October by $48.1 billion, the smallest gain in a year, the Treasury Department said last week. Treasury holdings rose by $18.3 billion.
Foreign central bank holdings of Treasury securities in accounts at the Fed was a daily average of $1.06 trillion as of the week ended Dec. 22, Little changed from the start of the month. The amount has risen every month since July 2003.
``The bears use this phenomenon'' of dollar weakness as a reason to bet on Treasury declines, said Ralph Axel, a government bond strategist in New York at HSBC Securities USA Inc.. HSBC is one of the 22 primary U.S. government securities dealers that trade with the Fed's New York branch. ``We have a lot of debt to finance.''
Axel expects 10-year note yields to remain within about 15 basis points of 4.25 percent for the time being.
Moves Exaggerated
Traders including Paul Calvetti at Barclays Capital Inc. in New York said trading was less than usual this week, leading to exaggerated price moves in Treasuries. Barclays is also a primary dealer.
A weaker dollar may actually be a reason to buy Treasuries if foreign central banks buy dollars to stem gains in their own currencies, said Calvetti. Those banks ``then in turn have to buy Treasuries'' with those dollars, he said.
The Treasury is scheduled to sell two-year notes next week. The sale will probably total $24 billion, said Jon Blumenfeld, a government debt strategist in New York at BNP Paribas, also a primary dealer.
In a sale of $15 billion of five-year U.S. notes on Dec. 8, so-called indirect bidders, which include foreign central banks, were awarded 66 percent of the sale, the biggest share since the Treasury began reporting the figure in May 2003.
Economic Signals
Orders for durable goods, which are items made to last at least three years, increased 1.6 percent last month, after falling 0.9 percent in October. Excluding aircraft and other transportation goods, orders fell 0.8 percent.
``There's no alarm bells'' from this data suggesting the Fed should remove the word ``measured'' from its policy statements that it has been using to characterize the pace of any future rate increases, said Axel. Based on this, investor expectations should remain intact for the Fed target to rise about another 100 basis points in 2005, he said.
Ten-year note yields are little changed from the start of the year and are down from the year's high of 4.9 percent, reached in May, on the view Fed increases will help keep inflation from accelerating. Quicker inflation erodes the value of bonds' fixed payments.
The personal consumption expenditure index excluding food and energy, a gauge of inflation tracked by Fed Chairman Alan Greenspan and other policy makers, rose 1.5 percent in November from the same month last year, the same rate as October. The Fed in July forecast the inflation rate would be 1.5 percent to 2 percent this year and 1.5 percent to 2.5 percent next year.
Laggard
U.S. government debt maturing in more than one year has returned 3.5 percent this year, including reinvested interest, the second-lowest among 26 government bond markets tracked by the European Federation of Financial Analysts' Societies. Japanese government debt has returned 1.5 percent. The returns don't take into account currency fluctuations.
A University of Michigan survey yesterday showed consumer confidence was higher this month than it previously estimated. The university's confidence index was 97.1 this month, rising from 92.8 in November, according to Market News Service. The preliminary reading, released Dec. 10, was 95.7.
A government report on Dec. 22 showed the U.S. economy grew faster than previously estimated in the third quarter and prices rose at a quicker pace. Gross domestic product expanded at a 4 percent annual pace, compared with an earlier estimate of 3.9 percent. Prices rose 1.4 percent, up from 1.3 percent.

To contact the reporters on this story:
Joshua Krongold in New York at jkrongold2@bloomberg.net.

Dollar Drops To Record Low On Speculation ECB Won't Weaken Euro

(Bloomberg) -- The dollar fell to a record against the euro as traders bet the European Central Bank won't step in to weaken the 12-nation currency.
The U.S. currency has declined for three years against the euro, the yen and the pound amid swelling budget and trade deficits and as officials ignored calls to stem its slide. French Finance Minister Herve Gaymard yesterday became the latest European official to decry the euro's strength, saying ``without any coordination, we can imagine a catastrophic situation.''
``We'll see the euro reach new highs in the first quarter,'' said Toshi Honda, a currency analyst in London at Mizuho Corporate Bank Ltd. ``I don't think the ECB will take action anytime soon.''
The dollar dropped to a record $1.3548 per euro and traded at $1.3537 at 11:46 a.m. in New York, from $1.3515 late yesterday, according to electronic currency dealing system EBS. The U.S. currency was also at 103.65 yen, from 103.59. The dollar has fallen 7.5 percent against the euro and 3.4 percent versus the yen this year.
Moves may be exaggerated today with U.S. markets closed for year-end holidays. Dec. 27 and Dec. 28 are also holidays in the U.K. Japan was closed yesterday.
``It's not surprising that small transactions in the market are having a large price impact,'' said Monica Fan, global head of currency strategy in London at RBC Capital Markets.
Not `Too Troublesome'
The euro's gains this year haven't been ``too troublesome'' yet, ECB council member Guy Quaden said in an interview with Belgian magazine Tendances published yesterday. ``Relevant authorities'' must confirm their statement at the last Group of Seven meeting that they are ``hostile to excessive volatility in the exchange rate,'' he said, according to the magazine.
``People are going to come back in the beginning of next year and pick up where they left off, pushing the dollar down,'' said Robert Rennie, senior currency strategist at Westpac Banking Corp. in Sydney. ``There's little the U.S. wants to do about it.'' The dollar may fall to $1.40 per euro and below 100 yen in the first quarter of next year, he said.
U.S. Treasury Secretary John Snow said in a Dec. 3 interview he has ``deep respect for the way markets perform,'' suggesting he won't accede to any European and Japanese calls for action when G-7 finance ministers and central bank governors meet in February in London. Efforts to manage currencies were ``at best unrewarding and checkered,'' he said on Nov. 17 in London.
Gaymard told manufacturers during a visit to Strasbourg yesterday the G-7 should discuss coordination to manage the dollar's decline.
`Pressure on the U.S.'
``They are going to try and place pressure on the U.S. to act as part of a G-7 coordinated intervention to try to stop the dollar's slide,'' said Simon Derrick, head of currency strategy in London at Bank of New York, referring to European and Japanese officials. ``I don't think that's going to occur.'' He predicts the dollar will fall to $1.40 per euro next month.
European Central Bank President Jean-Claude Trichet joined European finance ministers in urging the U.S. to halt the decline of the dollar on Dec. 7, saying that the currency's slide risks derailing global growth.
``All major countries and economic areas must play their part more actively in reducing global imbalances,'' Trichet said at a news conference in Brussels. No ECB officials are scheduled to speak in the coming week, according to the bank's Web site.
The U.S. has ``a strong dollar policy,'' U.S. Treasury spokesman Rob Nichols said two days ago. ``Our long-held currency policy remains unchanged,'' he said yesterday in an e-mailed response to a question about the administration's stance.
Decline Accelerates
The dollar's decline today accelerated after it breached $1.3517 per euro, a level where traders placed pre-set orders to sell the currency, according to Chris Melendez, president of Tempest Trading Technologies, a currency hedge fund in Newport Beach, California.
The U.S. currency is headed for a third consecutive annual decline, measured by the Federal Reserve's Trade-Weighted Major Currency Dollar Index. The last time it fell for three years in a row was during Ronald Reagan's second term when the Group of Seven negotiated the Plaza Accord in 1985 to weaken the dollar and the Louvre Accord two years later to stem its decline.
Japanese Finance Minister Sadakazu Tanigaki said on Dec. 7 said that he understood Europe's concern about the euro's gain and said ``we must take appropriate action,'' to address rapid moves in the yen.
Japan's currency is poised for the longest run of annual gains against the dollar in a decade. Rising Japanese stock prices may help lift demand for the currency, said Minoru Shioiri, manager of foreign exchange in Tokyo at Mitsubishi Securities Inc.
`Nice Rally'
The Nikkei 225 Stock Average rose 1.4 percent today, extending this year's climb to 6.3 percent. Foreigners bought a net 293.8 billion yen ($2.8 billion) of stocks in the week ended Dec. 17, the Ministry of Finance said today, more than this year's weekly average of 202 billion yen. Foreigners have been net buyers of Japan's stocks in all but nine weeks this year.
``A nice rally in Japanese shares makes people bullish on the yen,'' said Shioiri. ``The Nikkei should look even more appealing for overseas investors than its actual gains show because of the weak dollar.''
Gains in the yen may accelerate should it advance past 103.40 and 103.10 per dollar, where preset orders to buy may be clustered, he said. Traders place such orders to limit losses in case their bets go the wrong way.
Current-Account Gap
Federal Reserve Chairman Alan Greenspan said at the European Banking Congress in Frankfurt on Nov. 19 that foreigners may tire of financing the record U.S. current account deficit and diversify into other currencies.
A weaker dollar may help narrow the current account gap, which reached a record $164.7 billion in the third quarter, according to figures released on Dec. 16.
Foreign purchases of U.S. financial assets rose at the slowest pace in a year in October, the Treasury Department said on Dec. 15. Foreigners bought a net $48.1 billion, down from $67.5 billion in September.
``With a weaker dollar helping to ameliorate the size of the U.S. trade deficit, there's very little incentive for the U.S. administration to cooperate,'' said Fan at RBC Capital Markets.
RBC, which tied for most accurate forecaster for the euro in a third-quarter Bloomberg survey of 50 banks, predicts the dollar may fall to $1.40 in January, and to 100 yen within two months, Fan said.

To contact the reporter on this story:
John Beresford-Peirse at jbpeirse@bloomberg.net.

Will The Dollar Get Snowed Further?

by Ashraf Laidi
Forexnews.com

Now that US Treasury Secretary John Snow has been retained by President Bush, history suggests the dollar's secular bear market to continue. According to history, US Treasury Secretaries who emerged from the industrial sector or from a policy/politics background have served during a largely dollar negative period. Treasury Secretaries emerging from Wall Street (such as Donald Regan and Robert Rubin) have served during a period of dollar strengthening. The explanation naturally postulates the notion those secretaries with a manufacturing background pursue policies which are most friendly to US exports, hence favor a weaker dollar. Secretaries from the Wall Street--and even Larry Summers-- who hailed from a predominantly academic background, recognize the importance of a strong dollar to attracting foreign capital to US securities.
Pressured by US manufacturers, the Bush Administration started a campaign of abandoning the strong dollar policy (of 1995-2002) in order to push the dollar lower and help US exports. Despite recurrent touting of the "strong dollar" by the Bush Administration, the policy has become all "talk and no action".
It was back in December 2000, when the incoming Bush administration appointed Paul O'Neill as Treasury Secretary, that Forexnews deduced the relationship between the background of US Treasury Secretaries and the direction of the US dollar during their time in office.
Treasury Chiefs who had spent a considerable part of their career in the private sector, particularly banking and finance, have led through a strong period for the dollar. Treasury Secretaries emerging from a policy or manufacturing background have seen the value of the dollar largely heading lower.
Under the treasury tenure of:
DONALD REGAN 1/1981 to 2/1985, the value of the US dollar index soared 40%. Regan was a general partner at Merrill Lynch where he had a 35-year career.
JAMES BAKER III served as treasury secretary from 2/1985 to 8/1988. Prior to that he was Undersecretary of commerce, and worked on the presidential campaigns for presidents ford and reagan and served as chief of staff for 4 years under ronald reagan prior to becoming treasury secretary. During his tenure, the dollar index fell 26%.
ROBERT RUBIN was treasury secretary from 1/1995 to 7/1999. He had spent 26 years at Goldman Sachs. The Dollar index gained 20% during his tenure.
PAUL O'NEILL. Currency markets began speculating whether Mr. O'Neill's vast manufacturing background at Alcoa would lead him to follow policies that are in line with the interests of US manufacturers, i.e. a weaker dollar. Not only the dollar fell during O'Neill's time in office, but also extended to fresh lows upon the appointment of Secretary Snow in January 2003, who himself spent 20 years at CSX--the rail and freight giant. Even since, the dollar has continued to dwell in its bear market. At the end of Paul O'neill's 2-year stay in office, the dollar fell 21% off its highs.
JOHN SNOW's extensive experience in corporate America (25 years with CSX, one of the nation's largest freight companies, and head of the Business Roundtable) led us to predict a repetition of history. Two years into Snow's tenure, the dollar lost 29% against the euro and 10% against the yen.The last US Treasury Secretary with a manufacturing background BEFORE O'Neill and Snow was MICHAEL BLUMENTHAL who served in 1976-79. Prior to that, he spent 9 years at Bendix--a worldwide manufacturer of automotive and aerospace products. During his tenure, the dollar fell 9%.Naturally, the factors behind the dollar's moves are diverse, ranging from swelling unemployment in manufacturing and resounding protests against the strong dollar by the US manufacturing lobby, to the increasingly exposed US role in the shaky geopolitical landscape. Corporate scandals and accounting malfeasance as well as the imposition of trade tariffs in spring 2002 have also contributed to the dollar damage.The advantages of a weak dollar are two-fold:
1. Boosting the translation effect of US multinationals' foreign generated revenue into US dollars
2. Makes US more competitive, which raises demand for US exports. Although we are not seeing any positive export developments from the ensuing dollar decline, we should see a strong currency translation impact on US Q4 when the season starts next month. The "translation" effect is more immediate than the "exports" effect.

Currency Scorecard

(Bloomberg) -- Australia's dollar fell the most against the U.S. dollar this week among 16 major currencies tracked by Bloomberg, dropping 3.9 percent as of 5 p.m. in New York. None of the currency gained this week.
The following table shows the major currencies' performance against the dollar.

Percent Change

Taiwan dollar -0.91
Singapore dollar -1.28
British pound -1.50
Euro -1.70
Danish krone -1.73
South African rand -1.89
South Korean won -2.11
Mexican peso -2.15
Norwegian krone -2.26
New Zealand dollar -2.35
Brazil real -2.37
Swiss franc -2.55
Swedish krona -2.61
Canadian dollar -2.87
Japanese yen -2.98
Australian dollar -3.89

To contact the reporter on this story:
Mark Tannenbaum in New York at mtannen@bloomberg.net

BBC Portrays Derivatives Traders As Terrorists

(Bloomberg) -- You may think terrorists pose the greatest threat to civilization. You're wrong. It's derivatives traders, according to the British Broadcasting Corp.
The BBC broadcast ``The Man Who Broke Britain'' last night, a 90-minute spoof documentary, splicing interviews with actors portraying traders and government officials with genuine footage of Prime Minister Tony Blair and Chancellor of the Exchequer Gordon Brown.
The show played on three fears: The threat of terrorism, higher oil prices and those scary securities called derivatives, which everyone knows are weapons of financial mass destruction because Warren Buffett once said so.
The underlying message of the show was clear: Derivatives are dangerous, and the people who trade them are reckless gamblers who shouldn't be trusted.
As the program's voice-over explained, derivatives had given us ``lower mortgage rates, made our pension plans more profitable, even given us cheaper petrol.'' But there's a catch. ``These derivatives could transmit problems around the world faster than ever.''
It's Always The Quiet Ones
Our protagonist is Samir Badr, a Saudi Arabian described as ``the David Beckham of derivatives trading'' by the program's newspaper reporter, and as ``quiet, difficult to get to know, difficult to understand'' by his boss, Philip Crighton, the head of derivatives trading at Sun First Credit Bank, or SFCB
Now for the action.
On Jan. 5, 2005, terrorists attack Ras Tanura, the largest oil terminal in Saudi Arabia, the biggest oil producer in the Organization of Petroleum Exporting Countries. News footage of a burning oil installation is interspersed with the standard cliched pictures of men in garish jackets waving their arms around in a trading pit, culled from the International Petroleum Exchange.
As the price of oil surges, the derivatives traders at SFCB are trying to minimize their losses. Somehow, the bank's contracts are tied to the price of oil. As the crisis unfolds, trader Badr disappears from his desk.
The camera cuts to an interview with head trader Crighton: ``I said, `I think he may have done a Leeson.' What other logical explanation could there be?'' referring to Nick Leeson, the so- called rogue trader who bankrupted Barings Plc in 1995 after losing 791 million pounds ($1.5 billion).
Street Gamblers
Enter the U.K. Treasury minister, who explains that SFCB's problems are ``very different from Barings,'' because of its use of over-the-counter derivatives, a form of private securities contract, as opposed to securities traded on an exchange.
``It's the difference between gambling in a casino and gambling on a street corner with a complete stranger,'' the Treasury minister says. Uh-oh. An even more poisonous flavor of derivatives.
A character from the government's Joint Terrorism Analysis Centre describes the market as ``the Achilles' heel of the global financial market.'' And the danger posed by these derivatives is exemplified by SFCB's use of credit-default swaps, contracts tied to the creditworthiness of corporate bonds. The bank had added custom clauses to its swaps, which made the contracts null and void in the event of oil climbing to more than $75 per barrel.
Badr can't be found, so he's under suspicion for inserting those poisonous clauses. Maybe he's a financial terrorist?
Oil climbs to more than $70, from about $65. Then it passes $75. ``SFCB's losses soared from millions of dollars to billions,'' intones the narrator. SFCB declares itself insolvent.
Suicide Terrorist?
By Jan. 7, the police have found Badr in his silver Mercedes near his bank's headquarters. He's dead; red pills on the floor point to an overdose.
The suggestion is that Badr is some form of suicide terrorist, in cahoots with the attackers in his homeland of Saudi Arabia. After planting the $75 oil grenades in SFCB's derivatives trades, Badr has topped himself. A picture of him at an Islamic banking conference standing next to an alleged Syrian terrorist financier is slipped to the Financial Times newspaper.
``There were rumors of more sleeper cells, ready to sabotage more financial institutions,'' says the voice-over. The stock market collapses, and there's a run on commercial banks as nervous depositors retrieve their savings.
With the notion of terrorists bringing down the global financial system firmly embedded, the show introduces its twist and starts to spotlight the real baddies. ``Credit derivatives traders earn the highest bonuses in the City,'' says the narrator, adding that head trader Crighton is in line for a bonus of 7 million pounds.
Boosting Profits
By adding the oil clauses to SFCB's credit swaps as a sweetener -- effectively an embedded put option triggered by an unlikely event -- Crighton was able to cut his trading costs, boosting his profits.
``I've never been in so much trouble in my life,'' says Crighton.
The camera pulls back, revealing that all of Crighton's interviews took place in some sort of detention center where he's awaiting prosecution.
``We knew derivatives could be dangerous, and we'd let them become central to the world financial structure,'' says the U.K. Treasury minister.
I see where we're headed. In the 1970s, shadowy Arab investors were poised to destroy the global financial system. Then black-box computer systems were the worry. Rogue traders and hedge funds briefly topped the danger list. Now it's derivatives.
Any day now, we'll see a program about how the guys who run China's $540 billion of foreign exchange reserves are holding the world ransom. The accusation will be as misguided as the one made in last night's BBC program against derivatives traders.

To contact the writer of this column:
Mark Gilbert in London magilbert@bloomberg.net.

U.S. Budget Defict Widened To $57.9 Billion In November

(Bloomberg) -- The U.S. had a $57.9 billion budget deficit in November, up almost $15 billion from the same month a year earlier, as spending for the military and Medicare surged, the Treasury reported in Washington.
The excess of spending over receipts in the second month of the fiscal year compares with $43 billion in November 2003 and a median forecast of $54 billion. The government had a record deficit of $412.3 billion in fiscal 2004, which ended Sept. 30.
The last annual surplus was in 2001. The budget gap has widened every year since, aggravated by an economic slowdown, tax cuts under President George W. Bush, and U.S. military operations in Iraq, and the fight against terrorism. The shortfall, along with a record trade deficit, threatens to weaken the dollar and drive up interest rates, economists say.
``The administration is going to have a difficult time reining in the deficit amid the war and the potential terrorist threat,'' Richard Yamarone, chief economist at Argus Research Corp., said.
Spending rose 19.4 percent to $192.4 billion in November compared with the same month a year ago. Revenue rose 13.8 percent last month to 134.5 billion.
National defense expenditures increased 26 percent to $38.6 billion. Spending on Medicare, the program of health care for the elderly, rose 54 percent to $24.1 billion.
The Pentagon said yesterday that the monthly cost of U.S. involvement averaged $4.4 billion through August.
More Working Days
Government spending was unusually low in November 2003 because the first day of the month occurred on a weekend, meaning payments were shifted to October 2003, the Congressional Budget Office, a non-partisan agency of Congress, said this week.
November had two more working days this year, contributing to increased withholding of taxes and Social Security, the agency also said. Receipts from individual income taxes increased 17 percent to $58 billion.
For the first two months of the fiscal year, the deficit totaled $115.2 billion, up 2.4 percent from the first two months of the previous fiscal year.
Military spending so far this fiscal year totals $74.9 billion, up 7 percent from the first two months of fiscal 2004. Medicare spending is up 14.3 percent to $46.6 billion.
The median forecast of 33 economists in a Bloomberg News survey called for a $54.1 billion deficit for November. The Congressional Budget Office had projected a November deficit of $57 billion.
Budget Promises
The dollar reached a record low of $1.3470 per euro on Dec. 7, amid investor concern about the budget deficit and the current account trade deficit, which widened to a record $166.2 billion in the second quarter.
Joshua Bolten, the White House budget director, said yesterday that a combination of economic growth and spending restraints will reduce the deficit by half in the next five years.
Fiscal discipline by the Republican-controlled Congress may also enable the U.S. to absorb the cost of the president's plan to let workers divert some Social Security taxes into private retirement accounts, so long as the economy continues growing ``in the range of 3 percent per year,'' he said.
The Congressional Budget Office forecast in September that the deficit would shrink to $348 billion in 2005. That didn't account for several new proposals enacted by Congress.

To contact the reporter on this story:
Vincent Del Giudice in Washington vdelgiudice@bloomberg.net

Mexico Unexpectedly Lifts Rates For 9th Time in 2004

(Bloomberg) -- Mexico's central bank unexpectedly raised interest rates for a ninth time this year in a bid to fight inflation that accelerated in November to its fastest pace in almost three years.
``Month after month inflation has been worse than expected,'' said Hugo Penteado, Latin America economist for ABN Amro Asset Management in Sao Paulo and one of the five analysts among 18 surveyed by Bloomberg who predicted a rate increase. ``This was the last meeting of the year and they had no reason to wait to take action.''
Mexican consumer prices jumped 0.85 percent in November from the previous month, pushing up the annual rate to 5.43 percent, above the bank's 3 percent target. Electricity, tomatoes and liquefied gas led the November rise. Monthly inflation has increased in five of the past six months.
Banco de Mexico increased the amount commercial banks must borrow overnight at higher rates to 69 million pesos ($6.1 million) daily from 63 million pesos. Mexican authorities adjust interest rates by reducing or increasing the amount it lends at a rate that is double the going market rate.
Overnight Rates
Mexico's overnight interest rate rose 0.14 percentage point to 8.36 percent after the announcement. The rate is up from 5.5 percent on Feb. 19, the day before the central bank's first interest rate increase this year. The Mexican peso was down 0.6 percent against the dollar to 11.3280 at 11:56 a.m. in New York.
Inflation is accelerating as Latin America's largest economy grows at its fastest clip in four years. Gross domestic product expanded 4.4 percent in the third quarter from a year ago. Economic activity is expanding at a rate of 4 percent, led by surging domestic demand and exports, the Bank of Mexico said in a statement today.
The Bank of Mexico said it is trying to prevent the recent increase in fuel and agricultural prices from ``contaminating'' other prices and salaries. Mexican trade groups and unions must finish talks on an annual increase in the minimum wage by yearend, which ``is of special importance because it serves as a significant reference for other collective bargaining processes,'' the central bank said.
`Reminder'
``The central bank is sending a reminder that it hasn't given up on the inflation battle just before the minimum wage settlement,'' said Alonso Cervera, Latin America economist with Credit Suisse First Boston in New York.
A minimum wage increase of 4 percent, below last year's 4.25 percent raise, would be a sign that the central bank has inflation expectations under control, Cervera said.
Thirteen of 18 economists surveyed by Bloomberg expected the central bank to leave rates unchanged after the central bank boosted interest rates two weeks ago.
Central bank Governor Guillermo Ortiz probably will next raise interest rates in February, Cervera said, should inflation and inflation expectations decline next month.
Mexico's annual inflation is forecast at 4.3 percent next year and at 4.1 percent in 2006, according to the average estimate from 33 economists surveyed by the Bank of Mexico last month.

To contact the reporter on this story:
Adriana Arai in Mexico City at aarai1@bloomberg.net

Fed Governor Policy Statements Speak Louder Than Rate Actions, Study Shows

(Bloomberg) -- Federal Reserve policymaker statements that accompany interest rate decisions move markets more than the actual changes in benchmark borrowing costs, a Fed study shows.
``Surprises'' in the statements ``accounted for more than three-fourths of the explainable variation in the movements of the five-and ten-year treasury yields'' the occurred around the time of Federal Open Market Committee meetings, the study, written in November and posted on the U.S. central bank's web site, found. By contrast, stock investors still react to actual rate moves.
The findings suggests Fed Chairman Alan Greenspan's move toward greater transparency, including the issuance of statements that indicate the future path of monetary policy, is taking much of the surprise out of rate decisions. Investors are now focusing on changes in that path, according to the staff-written study.
``Anything that gives you insight into the trajectory of Fed policy is more valuable than the action on the day itself,'' said Mark Spindel, chief investment officer at International Finance Corp., the investment arm of the World Bank.
On Jan. 28, for example, the FOMC met and left the benchmark overnight lending rate unchanged, a move fully anticipated by the markets. However, the unexpected substitution of the phrase ``the committee believes it can be patient in removing monetary policy accommodation,'' for an earlier statement that said it would keep rates low ``for a considerable period'' surprised the markets.
Investors took that change to mean the Fed would raise rates soon, and within 30 minutes yields on the two-year treasury jumped 21 basis points and the five-year jumped 25 basis points.
Words, Not Actions
The study, entitled ``Do Actions Speak Louder than Words? The Response of Asset Prices to Monetary Policy Actions and Statements,'' was written by Fed researchers Refet Gurkaynak, Eric Swanson and Brian Sack, a former Fed economist who is now senior economist at Macroeconomic Advisors LLC. A study last year by Sack and Fed Governor Donald Kohn found that FOMC statements and speeches significantly affected market interest rates.
The FOMC meets again next week and 62 of 85 economists surveyed by Bloomberg expect the FOMC to raise the benchmark interest rate 25 basis points to 2.25 percent.
The IFC's Spindel, who manages $13 billion in government securities, said he fully expects a rate increase. ``I will pay attention to the statement,'' he said.
Central banks, including the Federal Reserve, are relying more on forecasts to set interest rates rather than rules based on current economic data, Fed governor Ben Bernanke said in a speech to the National Economics Club in Washington on Dec. 2.

To contact the reporter on this story: Alison Fitzgerald in
Washington at afitzgerald2@bloomberg.net

Questions To Ask Before You Sell That Next Dollar

(Bloomberg) -- The dollar is about as popular as a broken toy on Christmas morning. It seems to set fresh lows against the euro on a daily basis, while the threat of renewed yen sales by Japan hasn't arrested its slump.
The Bush administration may welcome dollar weakness as a balm for its trade and current-account deficits. The European and Japanese administrations have failed to talk the U.S. currency higher. In the past week, the dollar reached 101.83 yen, its weakest since January 2000, and a record $1.3470 per euro.
Before you jump on that bandwagon, here are some key questions, all of which address the same basic point: Do you really want to own euros and yen?
The Shoeshine Boys in Bolivia Know the Dollar's Going Down
The front cover of the Sunday Times newspaper's holiday supplement used the dollar's decline as a peg to extol the virtues of a holiday in the U.S. The front cover of the current Economist newspaper features a caterpillar munching its way through a tasty dollar bill. I'm willing to bet that the shoeshine boys in Bolivia and the street urchins of Vietnam are tapping tourists for euros rather than dollars these days.
Investment banks are elbowing each other out of the way in a race to post the lowest dollar forecast. Whenever ``everyone knows'' about a one-way bet, it's often time to consider becoming a contrarian.
One of the strange axioms of financial markets is that everyone agrees there's no such thing as a free lunch, until they think they spy a plateful of gratis set in front of them. Do you really think betting against the dollar is a free lunch?
North With the Fed, or East With the ECB and BOJ?
``Rising interest rates have been advertised for so long and in so many places that anyone who has not appropriately hedged this position by now obviously is desirous of losing money,'' said Federal Reserve Chairman Alan Greenspan on Nov. 19.
The Fed funds rate, currently 2 percent, is heading north. By contrast, the Bank of Japan's 0.15 percent benchmark rate and the European Central Bank's 2 percent lending rate are headed east at best; the ECB may even cut rates by half a point next year, according to economists at Goldman Sachs Group Inc.
Six months ago, putting a dollar on deposit for three months earned you about 1.4 percent; today you get more than 2.4 percent, while the rate on euros has been stable at about 2.13 percent. At some point, interest-rate differentials may start to matter to the currency market, if not for the yen then certainly for the euro. How long will you be willing to own euro deposits paying half a point less than you can get for holding dollars?
Santa Claus, the Tooth Fairy and the Strong Dollar Policy
When Robert Rubin took charge of the U.S. Treasury in January 1995 and smiled his Godfather smile and said ``a strong dollar is very much in this nation's economic interest,'' we believed him. A few weeks later, he put his money where his mouth was, intervening to bolster the dollar after it fell to a post-World War II low against the yen.
The dollar duly gained, from about $1.30 per euro when Rubin's tenure began to $1.02 at its end, based on a Bloomberg index that calculates the European currency's value prior to its introduction in January 1999. While the script stayed the same when Larry Summers took over in July 1999, his delivery of the lines Rubin used over and over again lacked sincerity. By the time Paul O'Neill became Treasury secretary in January 2001, policy had become platitude. These days, John Snow's manic grin gives the game away.
So, given that we all shelved our belief in the U.S. government's strong dollar policy at least half a decade ago, alongside our thoughts on Santa Claus and the Tooth Fairy, why is it a reason to sell dollars now?
It's the Economy, Stupid.
``Buy low, sell high'' is a pretty good trading tactic. ``Own the currencies of countries with strong economies'' has also proven to be an efficient strategy over the years. Are you sure you want to contradict this maxim?
The dollar's most recent lurch lower came after the Dec. 3 employment report, showing the U.S. economy added 112,000 workers in November, less than the 200,000 predicted by economists. So the sky is falling in on the U.S. economy?
``The economy has added a very respectable 2 million jobs to the payrolls in the first 11 months of the year,'' says Dennis Gartman, editor of the daily market bulletin Gartman Letter. ``That's an average of 185,000 a month, which is not peanuts. Further, that is consistent with an economy growing at or very near to its long-term average growth rate of about 3.5 percent.''
The U.S. economy grew 3.9 percent in the third quarter, outpacing the 0.3 percent rate for the 12 nations that share the euro, and the 0.2 percent growth rate achieved by Japan. The OECD is predicting U.S. growth of 3.3 percent in 2005, compared with 1.9 percent for the euro region and 2.1 percent in Japan.
Do you really want to own euros and yen?

To contact the writer of this column:
Mark Gilbert in London magilbert@bloomberg.net.

Masatsugu Asakawa And The Falling Dollar

From our friends at www.dailyreckoning.com:

Someone ought to thank him. Perhaps a little gift would be appropriate. Say, sleeping pills - or a hara-kiri sword. What the man needs now is sleep. Ritual disembowelment is for the future.
Masatsugu Asakawa, that is.
Without him, many Americans couldn't pay their mortgages. They couldn't buy more than they can afford at Everyday Low Prices at Wal-Mart. America's delusional EZ credit bubble would have already exploded - had it not been for Mr. Asakawa, who is the Japanese official with the daunting responsibility of managing Japan's $720 billion worth of U.S. government securities.
We saw his picture in yesterday's paper. The poor man looked tired, with circles under his eyes. In the text of the article, we found out why. It was just what we expected.
You recall, dear reader, how we've wondered why the Japanese continued to hold U.S. government paper in the face of a falling dollar? It made no sense. In the last three months, the dollar has lost 12% against euros... and 8% against yen. Let's see, 8% of $720 billion is $57.6 billion. That is a lot of money, even for people as rich as the Japanese.
"If you owe your banker $1,000, you don't sleep well," says the old American adage. "But when you owe him a million dollars, it's the banker who cannot sleep." Times have changed, of course, and in America both creditors and debtors sleep soundly - secure in the knowledge that Mr. Alan Greenspan is wide-awake, his bony fingers wrapped around every knob and lever of the Great American Economy of 2004. (More on that below...)
America is not only a debtor nation, but also the biggest debtor nation the world has ever seen. Its overseas liabilities total $3.3 trillion - or 28% of its GDP. No one has ever seen such a pile of debt. And no where are U.S. debts stacked higher than in Japan, where poor Mr. Asakawa tosses and turns at night - fearful that the whole mountain will fall down at any moment.
So worried is he that he keeps a sort of money seismometer ticking by his bedside, to alert him should the ground beneath him begin to give way. The International Herald Tribune reports:
"'This thing wakes me up, it is terrible,' Asakawa said as he toyed with a blue plastic portable currency monitor. After hours, the wireless device beeps by his bedside whenever the dollar strays beyond a set range."
Again, we stop dead in our tracks and hold our breath. We can scarcely believe it; what a wonderful, madcap world we live in. On one side of the world, 280 million people doze happily; apparently unaware that Mr. Asakawa could ruin their Christmas at any moment. All he has to do is pick up the phone and utter a single syllable: sell! In seconds, the U.S. bond market would begin falling apart. Seconds later, mortgage credit would disappear. Seconds later, stocks would crash...and real estate prices...and consumer buying...and GDP growth...and all the other delusions upon with the American consumer economy depends.
On the other side of the world, meanwhile...is Mr. Asakawa himself...with his ingenious little device by his bed. The alarm must have sounded more than once in the last few days, as the dollar sank on world currency markets. He must have sat up in bed, possibly in a cold sweat, wondering: Why do we still support the U.S. dollar? We are paying the price for America's overspending!
And then, waking, the horrible logic must have come back to him: Because we have no choice.
"With Japan's huge stake in the dollar losing value," explains the IHT, "the question is: What will Tokyo do next? The problem for Japan is that it is in so deep that, to a large degree, it is chained to its American debtor.
"Richard Koo, chief economist for the Nomura Research Institute, said that anything Japan might do to slow its dollar purchases would only create a self-inflicted wound. 'If they could move it all out of dollars in one day, I am sure they would do it in an instant,' Koo said. "But if they move 10%, and the dollar goes down 20%, they are stuck with 90% of the portfolio worth 20% less.'"
Poor Mr. Asakawa. The weight of the whole damned Dollar Era seems to ride on his shoulders. Experts now predict a further 20% decline in the greenback - maybe more. That will be a loss of $144 billion for Japan's central bank. But what then? How will he ever be able to get out? Or is Japan expected to finance America's deficits forever...no matter how much it costs?
We don't know the answers to these questions. But surely they come to Mr. Asakawa's mind when, in the dark of night, his dollar monitoring device goes off.

The $2 Pound May Save U.K. Economy From Decline

(Bloomberg) -- For the British, New York will be the cheap place to go shopping this Christmas. The pound is setting records against the dollar almost daily and is already cresting along at decade highs.
Currently at $1.94, it can only be a matter of days before the pound breaks through the $2 barrier, a psychological pivot last seen in 1992.
Periods of exceptional strength don't usually last long for the pound. Nor do they end happily. This time it might be different. The $2 pound may well be with us for a long time, reflecting its emergence as a haven currency.
That will have important consequences for the U.K. economy. It may allow the consumer boom that has fueled British growth to run longer than it otherwise would have. And it may dig the government out of the hole it has created with its budget deficit, which expanded to 24.1 billion pounds ($46.8 billion) in the fiscal year starting in April, based on figures released last month.
The pound's climb against the dollar is already three years old. The currency dipped below $1.40 in 2001 and has been rising steadily ever since.
That mostly reflects the weakness of the dollar -- while rising against the U.S. currency, the pound has fallen 3 percent against the euro in the past six months. So the increase in value of the pound doesn't reflect any new faith in the U.K. economy. It is part of the sell-off of the dollar, which has been falling in value against just about everything: the euro, the yen, an ounce of gold or a barrel of oil. The pound has been caught up in that.
Pound's Peaks
How does this compare with the last great period of sterling strength against the dollar? That was in 1991 and 1992. The pound went to more than $2 from about $1.60. Then by the start of 1993, it fell to almost $1.40. It hovered near the $2 mark for less than two weeks in September 1992 before starting its slide. Before that, the pound touched $2.44 in 1980, then fell steeply in 1981. In both the early 1980s and early 1990s, periods of strength were followed by economic weakness.
The lesson? That periods of sterling strength are usually short-lived. If and when the pound breaks through the $2 mark, history suggests that is the time to sell.
Unless, this time, it is different.
It is certainly easy enough to make out a bear case against the pound. It suffers from many of the same structural problems as the dollar. The U.K. may have a relatively fast-growing, high- employment economy -- rather like the U.S. -- yet it is also running a big trade deficit, which was 4.5 billion pounds in September. And its budget deficit is about 3 percent of gross domestic product. To make matters worse, Chancellor Gordon Brown has chosen to ignore it.
`Shorting the Pound'
Twin deficits, and politicians who appear unconcerned? We all know what country that sounds like.
``The foreign exchange markets could switch from bashing the U.S. dollar to shorting the pound, especially if the dollar is stabilized by higher U.S. rates and the prospect that President Bush will announce major social security reforms and a move towards a flat-rate income tax next year,'' said David Smith, chief economist at London-based brokerage Williams de Broe Plc, in a note to investors last week.
The markets paid no attention to the U.S. deficits for many years, then decided to hammer the currency. So just because they have ignored the U.K.'s shortfalls for years, it doesn't follow that they always will. Just as in the U.S., sooner or later those deficits will have to be fixed. A currency adjustment would be part of that.
The Bull Case
Yet that may be a long way off. In the meantime, it is just as easy to make a bull case for sterling.
The U.K. has one of the fastest-growing economies in the world -- 3.1 percent compared with 1.3 percent in Germany and 2 percent in France in the third quarter compared with a year earlier.
It has higher interest rates -- 4.75 percent compared with just 2 percent in the euro area, and almost zero percent in Japan. So, if you don't want to hold dollars, why not put your money into sterling? It has better growth prospects than the euro or yen, and better returns as well.
It is only a mild exaggeration to say that sterling is starting to have something of the Swiss franc's old role as a haven currency -- somewhere to stash your cash when all the other options look worse.
So don't expect a sudden slide in sterling once it passes the $2 barrier.
Asian Imports
For the British economy, that is important. As Charles Bean, chief economist at the Bank of England, pointed out in a lecture last month, the U.K. has benefited mightily from the gathering strength of sterling in the last few years.
``The international terms of trade -- that is the price of the goods and services we export relative to the price of those we import -- has moved in our favour,'' Bean said.
A strong pound will hurt manufacturing exporters to the U.S. and Asia. Yet that is now a relatively minor part of the U.K. economy. The biggest impact may turn out to be on the cost of the U.K.'s imports. Since some Asian currencies are pegged to the dollar, the pound is strong against those as well.
The result? The cheap Asia-manufactured imports, which have helped fuel the British consumer boom, are about to get even cheaper. That will keep a lid on inflation and ensure that the shopping malls are crowded through 2005.
At the same time, a strong pound will help the government fund its budget deficit. Just at the point where the U.K. economy looked poised for a sharp slowdown, a strong pound has ridden to the rescue.
The U.K.'s twin deficits may well worsen. Yet the markets will worry about that another day.

To contact the writer of this column:
Matthew Lynn in London at matthewlynn@bloomberg.net.

Dollar Rises Against Yen On Concern Japan May Sell Currency To Stem Gains

(Bloomberg) -- The dollar rose from an almost five- year low against the yen after Japanese Vice Finance Minister Koichi Hosokawa signaled Japan may sell its currency to slow the yen's appreciation.
``Recent yen gains don't necessarily reflect fundamentals of economies,'' Hosokawa said today at a press conference in Tokyo. ``We will act aggressively on its rapid moves in a timely manner.'' The yen climbed above 102 per dollar earlier today, a level Hosokawa identified on Dec. 2 as a concern for Japan.
The dollar rose by its most since Nov. 10, to 103.15 yen at 5:07 p.m. in New York from 102.10 late on Dec. 3, according to electronic currency-dealing system EBS. It fell as low as 101.91 today, compared with 101.83 on Dec. 2, the weakest since January 2000. The dollar strengthened to $1.3409 per euro, from $1.3454.
``The lower you go, the more potential you have'' for Japanese yen sales, said Grant Wilson, a currency trader in Pittsburgh at Mellon Financial Corp., which manages $612 billion in assets. ``Rhetoric starts to lose its effectiveness if that's all they use. You have to back it up. I would suspect they will defend 100'' yen per dollar.
The dollar may advance to 103.50 yen this week, Wilson said. The U.S. currency fell the past 10 weeks against the yen and dropped eight straight weeks against the euro.
Yen losses accelerated as the currency's fall triggered pre- set sell orders at levels including 103 per dollar, said Brian Taylor, chief currency trader at Manufacturers & Traders Trust Co. in Buffalo, New York, with $50 billion in assets.
Paying the Bill
Demand for the dollar has waned this year on concern a record U.S. current-account deficit will undermine demand for the currency. U.S. Treasury Secretary John Snow suggested in an interview last week he wouldn't attempt to stem the dollar drop.
``Recent sharp moves of exchange rates are unwelcome and not conducive to orderly adjustments of external imbalances,'' finance ministers from the 12 euro countries, European Central Bank President Jean-Claude Trichet and European Union Monetary Commissioner Joaquin Almunia said in a statement after meeting in Brussels. ``We will monitor the situation closely.''
A stronger yen reduces the value of Japanese exporters' U.S. sales. Kawasaki Heavy Industries Ltd. today said currency is the biggest risk it faces, and that its profit should rise in the year starting April 2005 if the yen stays weaker than 100 per dollar. Shares of European companies relying on the U.S. for revenue, such as Volkswagen AG, fell today.
New Face
Some U.S. companies are getting a boost. H.J. Heinz Co. last month said the weaker dollar bolstered sales in the quarter through Oct. 27.
``It's clearly not in Europe's or Japan's interest to have the dollar drop dramatically,'' said Jan Faller, who manages a global debt portfolio in New York at Deutsche Asset Management, with $696 billion in assets. ``The probability is not low'' that central banks will buy dollars some time this month.
Snow will be replaced and President George W. Bush is looking at several possible candidates, including White House Chief of Staff Andrew Card, the New York Times reported, citing Republicans with links to the administration. Treasury spokesman Rob Nichols declined to comment.
``We're flooding the world market with dollars'' through our trade deficit, former Deputy Treasury Secretary Stuart Eizenstat said in an interview. As for the dollar, ``it's inevitable that it will drop more,'' by perhaps as much as 10 percent next year, Eizenstat said.
No Plan to Divert
Snow said ``markets can overshoot and undershoot, and they often do, but the virtue of markets is they're self correcting,'' in an interview on Dec. 3. ``I'm not going to comment on what we might or might not do, but I will say I've got a deep respect for the way markets perform.''
The dollar has lost almost 21 percent since Snow was sworn in on Feb. 3, 2003, using a Federal Reserve index tracking the dollar against a blend of major currencies. The decline was the most under any Treasury Secretary since Ronald Reagan was president.
Japan spent a record 32.9 trillion yen ($320 billion) in selling its currency in the year through March 31, according to Ministry of Finance figures.
Japan urged the U.S. to participate in coordinated action to stop the dollar's decline, or it will face an ``enormous capital flight,'' the Observer newspaper said, citing Kaoru Yosano, head of the ruling Japanese party's policy council. The newspaper called Yosano's comment a threat that Japan will sell its holdings of Treasuries.
Soothing the Market
``We don't have such a plan'' to reduce dollar assets, said Masatsugu Asakawa, a Ministry of Finance official who manages the ministry's holdings of Treasuries, in an interview. Japan held $720.4 billion of Treasuries at the end of September, according to the U.S. Treasury.
Chief Cabinet Secretary Hiroyuki Hosoda also said at a press briefing that Japan has no specific plan to sell U.S. Treasuries.
``Japan's mandarins are doing their bit to soothe market concerns and take a bit of pressure'' off the dollar, said Ashley Davies, a currency strategist in Singapore at UBS AG. The Japanese government ``doesn't want a decline in the dollar but if it happens they want it to be orderly.''
The dollar fell to a record against the euro and dropped versus the yen on Dec. 3, after a government report showed U.S. employers added 112,000 jobs last month, less than half October's gains.
Japanese officials ``probably want to wait it out a little bit this time'' to be less predictable in their yen sales and because they're more confident in Japan's economy compared with earlier in the year, said Jeffrey Young, Tokyo-based head of currency research at Citigroup Inc.

To contact the reporters on this story:
Mark Tannenbaum in New York at mtannen@bloomberg.net;
Rodrigo Davies in London at rdavies13@bloomberg.net.

Brazil Sells Reais For The First Time Since February

(Bloomberg) -- Brazil's central bank sold reais for dollars for the first time in 10 months, following calls from the government and business executives to halt a rally in the currency that threatens to crimp exports.
The central bank said in a statement that it sold the local currency at a maximum exchange rate of 2.715 reais to the dollar. A central bank spokeswoman declined to say how many reais the bank sold. Alexandre Vasarhelyi, who heads currency trading at ING Bank NV in Sao Paulo, estimated the central bank sold less than $50 million worth of reais.
The real slid as much as 0.9 percent as analysts such as Bank of America Corp.'s Guillermo Estebanez said they hadn't expected the central bank to enter the currency market today.
``The timing was a surprise,'' said Estebanez, a currency strategist at Bank of America in San Francisco. ``I suspect they'll have to keep coming in. The market is still very bullish on the real.''
President Luiz Inacio Lula da Silva, Trade Minister Luiz Furlan and executives such as Banco Bradesco SA's Jose Guilherme Lembi de Faria have led calls in the past two weeks for a weaker currency. The real has surged 18 percent since May 20, cutting into profit margins for exporters, who have boosted sales abroad to a record high and led the recovery in South America's biggest economy.
Pares Losses
The real pared its initial losses. It was down 0.4 percent to 2.7205 reais to the dollar at 3 p.m. New York time. Estebanez said the central bank may be trying to prevent it from strengthening beyond 2.7 to the dollar. That ``seems to be the level they are signaling as the floor,'' he said.
ING's Vasarhelyi said the central bank will have to buy larger amounts of dollars in days ahead if it wants the real to weaken more.
``The intervention today was anything but aggressive,'' Vasarhelyi said. ``It was mild actually.''
Central bank President Henrique Meirelles said the bank is buying dollars to bolster its foreign reserves and isn't seeking to weaken the currency.
``The central bank is not committed to achieving any specific target, but it will seek to build reserves,'' Meirelles said today at a seminar in Rio de Janeiro.
Meirelles said the dollar purchases are a continuation of the plan the bank announced in January to accumulate foreign reserves. The bank abandoned those plans early in the year on concern the purchases would deepen a tumble in the currency. The real sank 10 percent in the first four and half months of the year before starting to rebound in late May, when concern eased about rising interest rates in the U.S.
Foreign Reserves
The central bank forecasts its net foreign reserves, or reserves excluding International Monetary Fund loans, will fall to $22.45 billion by year-end from $24.2 billion in October. Those reserve levels are less than one-third the $70.4 billion the central bank had in June 1998.
``They are building reserves because they need to,'' Michael Gavin, chief Latin America economist at UBS Securities LLC, said in a telephone interview from Stamford, Connecticut. He said he doesn't think the central bank is trying to weaken the currency because its rally has held import prices in check and helped prevent a surge in inflation.
Annual inflation is running at 6.9 percent in Brazil, above the government's 5.5 percent target for this year and 4.5 percent target for 2005.
Today's transaction is separate from the dollar purchases that Brazil's Treasury has planned for the next seven months, central bank spokesman Jocimar Nastari said in Rio de Janeiro.
Treasury Purchases
The Treasury will buy about $2.4 billion through June 2005 to help raise the hard currency needed to pay its foreign debts, Afonso Bevilaqua, the central bank's chief economist, said on Nov. 24. While the central bank announced those purchases, it won't take part in them because the Treasury will carry out most of the purchases through Banco do Brasil SA, a state-run bank, Nastari said.
Lula said in an interview on Nov. 23 that the real needs to fall to as low as 3.1 reais to the dollar to bolster exports. Furlan said the currency's rally has led some companies to consider halting exports because they're no longer profitable.
Brazil's economy is expanding at its fastest pace in eight years, led by a 19 percent jump in exports such as soybeans and auto parts in the first 11 months of the year to a record $87.3 billion. The economy grew 6.1 percent in the third quarter.

To contact the reporter on this story: Guillermo Parra-Bernal in
Sao Paulo at at gparra@bloomberg.net

Lee Kuan Yew's Contrarian Outlook For U.S.

(Bloomberg) -- Anyone visiting Vientiane, Laos, last week, when 13 Asian leaders met, could be excused for wondering if George Soros is right about the U.S. economy.
Soros painted an ominous picture of America's future in his book ``The Bubble of American Supremacy.'' Judging by how the U.S. seemed all but ignored by leaders attending the Association of Southeast Asian Nations, or Asean, summit, Soros might be on to something.
When the U.S. did come up, it was often in a negative light. What if the dollar crashes? When will the U.S. stop living beyond its means? Will the mess in Iraq ever get sorted out? Might the Bush administration invade North Korea? How will the Federal Reserve's interest rate increases affect Asia?
Pushing the U.S. to the sidelines was China, and the talk was of how craftily it is forging economic ties in Asia, Europe, Latin America and Africa. China seems to be spreading its tentacles everywhere, taking advantage of a U.S. distracted by war, terrorism and internal squabbles.
The idea that China is destined to eclipse the U.S. someday is hardly new. Yet events in Vientiane left the impression the role reversal may happen sooner than most dared to think.
Lee Supports U.S.
So is the U.S. economy becoming old hat in Asia? No, according to at least one of the region's best-known thinkers, Lee Kuan Yew, minister mentor of Singapore.
``America is the most dynamic economy in the world,'' Lee said last week at a seminar organized by BusinessWeek in Bangkok.
Lee's comments were in response to a question by an American biotech executive who lamented that the U.S. is having difficulty competing globally. ``I'm completely of the contrary view,'' Lee said.
Europe, Lee noted, has myriad structural challenges that hamper economic efficiency and productivity. Japan, too, will ``take some time to pick up'' because of numerous impediments to growth, Lee added. And with China's economy very much a work in progress, the U.S. economy wins top billing.
Again, Lee's take on the U.S. seems a bit contrarian here in Asia, where many see China's population and its economic trajectory as rivaling the U.S. sooner rather than later.
Lee's not buying it, at least not in the near term. While he thinks there will be an economic shift ``from the Atlantic to the Pacific'' in 20 years, he thinks those who bet against the U.S. economy may regret it.
All Things China
The 81-year-old Lee was known for taking pro-U.S. stances when he was Singapore's prime minister from 1959 to 1990, as well as in the powerful advisory role he has played since then. U.S. multinational corporations, after all, formed one of the pillars of Singapore's economic growth. Lee's comments aren't about currying favor; they toss a dose of sobriety at investors' infatuation with all things China.
Remember that just 20 years ago, Japan was supposed to eclipse the U.S. and rule the world. These days, it's grappling with deflation, an aging population and modest growth. It's not a bad thing to have a sober observer or two point out that things may not turn out as the herd expects.
China Aviation Oil (Singapore) Corp. also is a reminder that investing in China comes with huge risks. It's being investigated after disclosing $550 million of losses on speculative oil trades. Singapore state investment agency Temasek Holdings Pte owns a less than 2 percent stake in the company and has been approached for a bailout. Bottom line, China's risks are spilling over into other markets.
U.S. Debt
Lee could easily be wrong, too. It's bad enough that the U.S. is building up ever-growing amounts of debt; signals are that the record U.S. budget deficit will continue expanding.
The U.S.'s debt situation has another well-known Asian thinker -- former Prime Minister Mahathir Mohamad -- singing a very different tune. Dubai newspaper Gulf News last week reported Mahathir as saying that the U.S. economy is standing on ``feet of clay'' and that ``if people do not keep giving money to the U.S., it will go bankrupt.''
An overstatement, perhaps, but investors are getting antsy about the twin deficits bedeviling the U.S. The budget gap reached $412 billion in the fiscal year ended Sept. 30, or 3.8 percent of gross domestic product, the highest in a decade. The record current-account gap is approaching 6 percent of GDP.
Could Be Right
The conventional wisdom about China overtaking the U.S. as the world's dominant economic power could indeed be right. Yet investors should pay close attention to Lee's caution. After all, many observers think China aspires to become a giant Singapore --a place that embraces free markets, yet with a stern guiding government hand.
Lee has closely monitored China's transition from socialism to capitalism. He probably understands China's promise more than most, as well as the magnitude of the task facing officials in Beijing. They must simultaneously avoid economic overheating, reduce poverty, repair a financial system riddled with bad loans and maintain social stability.
All this is a reminder that those eager to reduce U.S. influence in Asia may have longer to wait than they hope.

To contact the writer of this column:
William Pesek Jr. in Bangkok, through the Tokyo newsroom at wpesek@bloomberg.net

Taiwan, South Korea Currencies Slump As Central Banks May Sell

(Bloomberg) -- The Taiwan dollar had its biggest decline in six months yesterday and the South Korean won and Singapore dollar dropped on speculation Asian central banks will sell their currencies to protect exports.
Taiwan's dollar had its first weekly loss in 10. Gains in the island's currency reduce the value of sales for exporters such as Taiwan Semiconductor Manufacturing Co. South Korean President Roh Moo Hyun said the government needs to ``appropriately manage'' the currency.
``Asian central banks are still not ready'' for a large appreciation in their currencies, said Chan Cheh Shin, who runs foreign-exchange and fixed-income funds at DBS Asset Management (Singapore) Ltd., which invests $3.7 billion. ``They still think they need to export their way'' out of an economic slowdown.
The Taiwan dollar yesterday dropped 0.7 percent to NT$32.20 against its U.S. counterpart, its largest slide since May 10, according to Taipei Forex Inc. The won declined 0.4 percent to 1,045.50, the biggest loss since Nov. 10, according to Seoul Money Brokerage Services Ltd. Chan doesn't plan to buy either currency in coming months, he said.
Foreign-exchange reserves in South Korea rose $14.2 billion to a record $192.6 billion in November, the biggest-ever monthly gain, partly as the central bank bought dollars to stem the won's appreciation, the bank said on Dec. 2. Taiwan's reserves rose in November for a 41st month to an all-time high of $239 billion, the central bank said yesterday.
Managing the Situation
Taiwan's dollar fell 0.3 percent this week, after gaining 5.6 percent over the previous nine weeks.
The won had its 10th weekly gain, rising 0.1 percent, on speculation exporters converted their overseas profits, betting the U.S. dollar will extend its decline.
``The government at times needs to appropriately manage the situation,'' Roh said at a news conference on Dec. 2 in London with British Prime Minister Tony Blair. ``Still, we can't go too far to distort the market.''
``If the next few weeks brings another bout of dollar weakness against the won, I expect more intervention'' in the form of currency sales, said Jan Lambregts, Singapore-based head of Asia-Pacific research at Rabobank's treasury department. Roh is not ``ruling out entirely'' that the central bank will sell won, which may hold near current levels toward the end of the year, Lambregts said.
Taiwan's export orders rose in October at the slowest pace in nine months, the Ministry of Economic Affairs said on Nov. 23. Orders, indicative of shipments in one to three months, increased by 25 percent from a year earlier to $20.3 billion after climbing 27 percent in September.
Slowing the Gain
``The market is worried that the central bank may sell the currency to slow its gains,'' said Joseph Lee, a foreign-exchange trader in Taipei at Cathay United Bank. ``Any strong intervention by the central bank'' to sell Taiwan dollars ``signals NT$32 may be the authority's bottom line.''
The currency on Dec. 2 rose past NT$32 for the first time since November 2000.
South Korea's export growth may taper off this month after sales overseas rose 28 percent in November from a year ago to a record $23.3 billion, Suh Young Ju, director general of the commerce ministry's trade policy bureau, said on Dec. 1. Sustained won gains ``will hurt exports,'' he said.
In late Asian trading yesterday, the Singapore dollar fell 0.5 percent to S$1.6430 on speculation the central bank sold the currency. The Monetary Authority of Singapore, known as the MAS, declined to comment on the speculation.
The central bank targets the currency instead of interest rates to guide the economy and control inflation. It acts to keep its dollar within an undisclosed band against a basket of currencies.
The Thai baht slid 0.4 percent to 39.33, and Indonesia's rupiah weakened 0.4 percent to 9,064.
The Indian rupee fell 0.1 percent to 44.135.

To contact the reporter on this story:
Christina Soon in Singapore at csksoon@bloomberg.net.