Why the Dollar Isn’t Benefiting from the Arab Revolutions

The dollar has lost ground against all major currencies (except the New Zealand dollar) since Jan. 24, the beginning of the revolution in Egypt. In February, gold rebounded to 57 percent. The Swiss franc, the yen, the pound sterling and the euro have all benefited from events affecting the dollar.

Nevertheless, Europe is geographically much more exposed to the risk of destabilization in the Arab world; besides the fact that the Euro governance crisis is not completely settled; and the fact that the economic situation in Greece, Ireland and Portugal is pretty bad and casts doubt on the success of the policies of the International Monetary Fund and the European Union.

Why isn’t the dollar playing its role of a safe haven? I see three explanations for this phenomenon.

1)The anticipation of rising interest rates unfavorable to the dollar

Wrong or right, investors give more credit to the European Central Bank than to the Federal Reserve in the fight against inflation. They see the Fed tolerating a temporary rise in prices induced by higher commodity prices. They believe that the European Central Bank will be the first to raise interest rates if inflation worsens in Europe.

The Fed has repeated so much that it will keep rates very low for a very long time that everyone everywhere believes them.

2)The absence of ideas from Obama to reduce the U.S. budget deficit

Barack Obama continues to let Republicans propose public spending cuts. His budget plan announced in mid-February was criticized by the ordinarily pro-Democrat press; in the short term the White House doesn’t want to seriously reduce public spending.

In the medium term, the White House says that it wants to negotiate a package of spending cuts, along with tax reforms and income increases. But mainly it is letting Congress figure out the details. Without direct involvement from the president, nothing is going to happen.

This fiscal laissez-faire contrasts with the austerity that many European countries have implemented, in the short term and especially in the medium term.

3)The Fed’s flexible monetary policy is considered inflationary

Ben Bernanke’s “quantitative easing,” launched in November, hasn’t convinced anyone but the Fed chief’s friends. We see a program of printing $600 billion in greenbacks at a time when the U.S. economy is accelerating. It is no longer certain that this project will be discontinued as the Fed suggested in June.

4) The dollar’s decline is approvingly watched by the White House

The dollar is rarely discussed in Washington. The Obama administration’s desire to stimulate exports and reduce imports is aided by a slow erosion of the greenback.

5) Rising oil prices threaten the U.S. economy more than Europe

The U.S. economy is more sensitive to rising energy prices than the European economy. First, it consumes more energy. Second, the energy is not taxed as much, and therefore the price volatility is higher for the U.S. consumer.

Conclusion

These votes of no confidence against the dollar may reverse in the coming weeks if … a) the European economy slows more than expected … while at the same time b) the U.S. economy’s momentum proves stronger than expected, especially in the case of job creation … c) serious discussions begin for reducing the budget deficit … d) the public debt crisis and the weak governance in the eurozone quickly return to the forefront … and turn against those who sold dollar futures …