HardAssetsInvestor

This segment was taped at the American Stock Exchange, which offers trading across a full range of equities, options and exchange-traded funds.

Michael Woolfolk, senior currency strategist for The Bank of New York Mellon, examines the forces pushing the dollar lower.

Mike Norman, Anchor, HardAssetsInvestor.com (Norman): Hello again, and welcome to another installment of HardAssetsInvestor.com’s interview series. I’m Mike Norman, founder and publisher of the Economic Contrarian Update. Today my guest is Michael Woolfolk, senior currency strategist at the Bank of New York Mellon. Michael, thank you very much for coming on our interview series.

Michael Woolfolk, Senior Currency Strategist, Bank of New York Mellon (Woolfolk): Thank you for inviting me today.

Norman: It couldn’t be timelier because as we sit here, we look at another wave of selling in the U.S. dollar, which recently hit a record low against the euro and a three-year low against the Japanese yen. Can you tell us what is driving this bearish sentiment and this selling in the U.S. currency?

Woolfolk: Certainly. What we’ve seen is a continued deterioration this week in U.S. economic data. Specifically, consumer confidence has disappointed on the downside Tuesday [March 11]; durable goods came in weaker than expected on Wednesday [March 12]; and Thursday [March 13] we had GDP that came in below expectation.

On top of that, Donald Kohn, the vice chairman of the Federal Reserve Open Market Committee, and [Fed Chairman Ben] Bernanke this week have been very consistent in the message that they are sending out to markets, and that is that they will be cutting interest rates. They say that the downside risk to growth is their primary concern. They’re not concerned about the rising inflation we’ve been seeing recently.

Norman:OK, but is it then really an interest rate story? Because, let’s face it, even though growth is slowing here in the United States, it’s also slowing in Europe, but yet we see the euro continue to appreciate. Is it merely an interest rate story or is there something else behind it?

Woolfolk: I think that it is primarily an interest rate story, but we can’t be that simplistic about it. It’s also a growth rate story. Things are slowing globally, not only in the U.S. and Europe, but globally, but probably not at the pace that some have expected. We’re going to be seeing roughly about zero percent growth perhaps in the first half of this year. Europe will see something on the order of 1.5 percent growth. So even though Europe is slowing on a relative basis, they’re still growing faster than us.

We’re having difficulty attracting foreign investment into our stock and bond market currently, which also is undermining the dollar. Speculative selling of the U.S. dollar in anticipation of further weakness also complicates things a bit more.

Norman: Let’s talk about that, because I think that’s a big element not only in the currency markets, but [also] with regards to commodity markets. I guess you could say for the last several years the decline in the dollar has been somewhat justified. You can look at the budget deficit, the trade deficit, etc., but we’ve started to see the trade deficit narrow. It narrowed last year versus 2006, it looks on track to narrow again, exports are really starting to ramp up. We even saw the budget deficit go from 4% of GDP in 2003 to about 1.2% last year, so some of these macro economic arguments that investors could have used to be negative on the dollar seem to be diminishing somewhat.

Woolfolk: Well, certainly. At the end of the day, currencies’ real values are driven by trade investment flows. We have a structural trade deficit; we have slightly different but very similar definitions.

The current account deficit, which is about 5% of GDP, is only sustainable at that level for the U.S. because of a very unique role that the U.S. dollar plays in the global financial system. It is the dollar that denominates oil and gold and commodities, so when South Africa sells gold to the U.K. or Saudi Arabia sells oil to Japan, they get U.S. dollars in return. They typically don’t spend those windfall profits right away; they put them in dollar-denominated securities. So we have a kind of dedicated purchasing of dollar-denominated securities that we wouldn’t otherwise have.

Still, we need to attract, again, approximately 5% of GDP every year in terms of foreign investment. That has been on the wane as the U.S. stock market has had a difficult time competing with other stock markets globally for returns, and our interest rates are not particularly attractive just now.

Norman:You talk about that dedicated segment of dollar buyers, the oil-producing nations. Some suggest now that they’re going to start to move away from the dollar as the currency in which their commodity is priced. Do you think that’ll happen?

Woolfolk: I don’t think it’ll happen immediately. I think that eventually it’s going to be a risk. I think that we need to follow it very closely. It would be a negative for the dollar.

Norman: All right, and we certainly will be following it very closely, along with many other developments here on HardAssetsInvestor.com. Stay tuned for segment No. 2, which is coming up.