Monday, January 21, 2008

Has the US Dollar bottomed out?...

I know, I know...I said that I would report on the US dollar once a month, sometime during the first week of each month. However, things seem to be changing quickly so I thought I'd better give my two cents worth. First, a disclaimer...In case you didn't know, and most of you should, I am no economist. I took a class of Macro as part of my MBA program, and I didn't like it. And I make no claim to any particular expertise in the subject.

As I write this (Monday, 21 JAN at 4:30 PM Prague time) European markets are down big time - about 5.6%. That would be equivalent to a drop in the Dow today of 780 points. Pretty serious stuff. It is likely that the Dow will have another down day, but I don't think it will be down anywhere close to 5%.

It appears that Europe is catching the sub-prime flu that the US has been suffering from for the past few months. One reason that the dollar has been hit so hard is that fear of recession in the US has caused the Fed to drop interest rates to spur activity. It also has the benefit of making variable mortgages a lit more affordable for those who got them and watched as the rates jumped up over the last year or two.

Kathy and I had a variable rate home equity loan on our house back in Minnesota. It was a sizable loan (we did a LOT of work on the house) and the monthly payment had started going up regularly - and we felt it. Fortunately, the home equity loan was paid off when we sold our house almost a year ago. But others were not as fortunate, and unexpectedly higher payments has both raised foreclosures and bankruptcies and left less money to spend for those who haven't actually lose their homes.

In Europe, on the other hand, inflation has been a problem - in the Czech Republic inflation was over 5% in 2007 - so the central banks have been raising rates to dampen demand to keep inflation in line. While a slow down, or full fledged recession, is a distinct possibility in the US, it seemed less so in Europe and elsewhere. The old conventional wisdom was that as the US economy went so went the rest of the world. The new conventional wisdom is that the influence of the US economy is less pronounced than before and that it won't drag others with it.

In my opinion, the new conventional wisdom is wrong and a worldwide recession is possible, even likely since a recession is likely in the US. Europe has a housing bubble similar to what existed in the US and with the big drop in the markets here today we may be seeing the initial leak in the bubble.

So, what will happen to the dollar? It has trended down significantly to the Czech koruna recently. It spiked upward to about 18.40 from a low of 17.65 in December before falling back, and is back up to about 18.15 now. My prediction is that the dollar will trend upwards for the foreseeable future. European central banks will have to revisit rate increases and may even have to cut rates if a recession is perceived to be on the horizon. Interest rates should be heading down on both sides of the Atlantic so the dollar shouldn't get worse.

The price of oil has also dropped dramatically in the past week, from a high at $100 per barrel down to $88 today. Expect that price to continue dropping as the spectre of a recession, with lower demand, looms.

A world wide recession is a steep price to pay for a stronger dollar compared to the koruna. My rent and groceries may well be a bit cheaper but jobs will be harder to find as demand drops and the layoffs start.

I hope I'm wrong about the recession, but I feel strongly that the dollar will get stronger versus the Euro and other European currencies during the rest of 2008. I will report again as usual during the first week of February.

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