Protectionism Hurts the U.S. Dollar

Good day… Friday started out pretty much as a repeat of Thursday, with much of Friday’s data positive for the U.S. economy and giving the dollar some strength. The dollar rose against the euro and yen after the PCE numbers (the most closely watched inflation measure) gained in February. The dollar extended its gains when the National Association of Purchasing Management – Chicago’s business barometer – rose more than economists forecast.

After these numbers, it looked as though we were going to see the dollar move up slightly, just as it did the day before. But at around 10 CST, a bombshell hit the markets: The U.S. Commerce Department decided to begin to levy new duties on imports from China to compensate for Chinese subsidies to exporters, reversing more than two decades of its practices.

The Bush administration, which debated the change internally for months, faced pressure to expand the tariffs from steel companies, textile producers and other manufacturers and their advocates in Congress. Secretary of Commerce Carlos Gutierrez announced the change at a press conference in Washington.

This change is one of the biggest alterations of U.S. trade laws in decades and could open the way for a flood of new trade complaints by U.S. manufacturers hurt by surging imports from China. The Chinese government lost a U.S. court case Thursday aimed at preventing this decision.

Currency markets sell the currencies of nations engaged in protectionism, and the U.S. dollar got sold as soon as the announcement was made. As an email sent to me on Friday pointed out, the recent peak of the U.S. dollar occurred in February of 2002. And what was the event that started the dollar on its five-year slide to where we are today? The U.S. administration’s decision to slap tariffs on steel. That decision, though reversed by the WTO more than a year later, helped trigger the massive sell-off in the dollar over the last five years.

These new tariffs may again be reversed by the WTO, but the risk is if China decides to retaliate. We shouldn’t forget that China has more than one trillion ways to fight back. If it decides to, China can simply reallocate some of its massive currency reserves away from the dollar and send U.S. interest rates spiraling up. Yes, China is already diversifying some of its reserves away from the United States, but an acceleration of this process could be very bad indeed.

Just last week, the IMF reported that the dollar’s share of global foreign exchange reserves fell to the lowest level in at least eight years, as central banks accelerated their purchases of euros. Dollars accounted for 64.7% of reserves last quarter, down from 65.8% in the prior three months.

The share of euros climbed to 25.8% from 25.1% reaching its highest proportion since it was introduced in 1999. In addition to showing how central banks are diversifying, these numbers also show just how much more diversification is needed (and is becoming more and more likely).

Chuck got back from Spring Training this weekend and looks like he was working hard Saturday getting caught up on emails. He sent me the following on the Commerce Departments actions:

“While we’ve been talking about the Schumer and Graham proposed protectionism/tariff acts, this latest development by the Commerce Department really caught me and the markets off guard. For years an Ohio Company claimed that Chinese imports of glossy paper were subsidized. Up until Friday, the Commerce Department ignored those complaints.

“I think that the markets are really going to take the view that this is just a baby step towards rising protectionist measures that the United States will take… And as I’ve explained ever since the protectionist measures were put on steel in the first Busch term, this is bad for the dollar. The markets do not want to see anything that restricts free flow of goods and services.

“I think the real meat in this move is yet to come… And that is how China responds to this announcement. If they don’t respond, then the warning light for the dollar remains on amber; but if China does anything to retaliate…watch out! A full fledged trade war could be on our hands, and if that happens the warning light on the dollar turns bright red!

“There is another thing to think about here too… If China’s response is muted, I think it gives legs to the “anti-China” pieces of legislature that are already in progress. The backers of these protectionist acts will feel that they have a Big S on their chests, and will push harder for the passage of their dumb laws.

“As always, I feel that this is not what’s best for the United States, or it’s economy at this time… Nor the dollar. But apparently lawmakers believe they know best! We’ll see who’s right when the dust settles on this.”

I guarantee Chuck will have more on these new tariffs as events unfold.

Over the weekend, China’s response was muted. The decision to impose tariffs on coated paper was described as “unacceptable” by China. “We’ll closely monitor and reserve the right to take any necessary action,” said the Chinese Commerce Ministry spokesman. Later, the Renminbi was little changed following comments from the central bank reiterating it will improve the currency’s managed float.

The central bank said it will “strengthen coordination of the internal and external currency policies with its liquidity control” and will be more “preemptive” and “effective” in its policies. The G-7 and IMF will hold separate meetings in Washington this month, so we could see faster appreciation of the Renminbi prior to these meetings.

While the tariffs dominated the markets, there were other events that helped push the dollar down. The British pound rose against the dollar and the euro on speculation that the Bank of England could surprise the market with an interest-rate increase this week to quell inflation. The pound is the second best performing currency in the past 12 months and has benefited from three interest rates increases since August, two of which were unexpected by the markets. It will be interesting to see if the BOE decides to surprise with another increase at their meeting on April 5th.

The currencies “down under” have rallied again over the weekend with the Aussie dollar surging to a 10-year high, trading above 0.8150 and the kiwi trading over 0.72. The Australian dollar rose, as retail sales and building permits signaled another rate increase. Australian retail sales rose twice as fast as expected in February, and home-building approvals surged. The Reserve Bank of Australia holds its monthly meeting on interest rates tomorrow and these latest figures support another increase in rates.

The New Zealand dollar gained along with the Aussie dollar as a report released last week showed that their current account deficit narrowed in the fourth quarter, as rising world prices for butter and milk buoyed exports.

New Zealand is the world’s largest exporter of dairy products, mostly into the Asian markets. The large current account deficit has been a concern of ours for the last few years, and the narrower deficit suggests exports may be starting to replace domestic demand as a driver of the economy’s expansion. The current account gap, which narrowed to 9% of GDP, is still too high. While the currency has done very well over the past 12 months, I still believe investors are safer in the Aussie dollar, which is less vulnerable to the “carry trade” and has a fundamentally stronger economy.

A story in Friday’s Financial Times stated that boom times are back to the Tokyo property market. The story highlighted a huge multi-function project, which opened its doors to the public in Tokyo this weekend. It features a 54-story tower housing a Ritz Carlton hotel, two museums and luxury penthouses. Here is a snippet from the Financial Times:

“Tokyo’s property market is in the midst of an investment boom the likes of which have not been seen since Japan’s asset price bubble burst 17 years ago. Property prices in the capital have been surging upwards in the past two years, with prime plots of land enjoying annual increases of 30-40 percent, according to a government study released last week.”

The Financial Times story is a great advertisement for our latest MarketSafe creation: The 3.5-year Japanese REIT MarketSafe CD, which is being offered in April. Please email us at for more information on this latest offering.

Currencies today: A$.8148, kiwi .7190, C$ .8651, euro 1.3358, sterling 1.9744, Swiss .8236, ISK 66.14, rand 7.265, krone 6.1085, SEK 7.0053, forint 184.71, zloty 2.8835, koruna 20.91, yen 117.70, baht 32.50, sing 1.5174, HKD 7.8157, INR 43.29, China 7.7355, pesos 11.0393, dollar index 82.91, Silver $13.315, and Gold $661.95

That’s it for today… Just a beautiful spring day yesterday for the Cardinal’s home opener. I wasn’t able to make it down for the game, but watched it on TV. Looked like downtown St. Louis was blanketed in a sea of red. I’m sure Chuck will let us know all about the ceremony, as he was down in the middle of it all. Hope everyone has a great start to their week!

Chuck Butler — April 02, 2007

The Daily Reckoning