The following article was published in The Wall Street Journal on March 5, 2003. Read it carefully and answer the questions that follow.
Date Due: April 26, 2005
March 5, 2003
Treasury Secretary’s Words Send Dollar Sharply Lower
By AGNES T. CRANE
DOW JONES NEWSWIRES
NEW YORK—The dollar fell swiftly Wednesday, after off the cuff remarks from U.S. Treasury Secretary John Snow sparked a wave of selling that pushed the Swiss franc—and briefly the euro –to fresh four-year lows.
In late dealings Wednesday, the dollar was at Y117.25, down from Y117.95 late Tuesday in New York. The euro was at $1.0965, up steeply from $1.0886 late Tuesday. Against the Swiss franc, the dollar was at 1.3301 Swiss francs up from 1.3393 francs late Tuesday in New York. Sterling was at $1.6013, compared with $1.5807 late Tuesday in New York.
Speaking to reporters after testifying before the House Ways and Means Committee late Tuesday, Mr. Snow said the dollar is trading within a normal range and that he did not “see anything troubling” about recent declines against other major currencies. The comments had more resonance as they came on a day that the dollar was in any case weakening.
Traders viewed the remarks as tacit approval for a softer greenback, a marked departure from the strong dollar policy in place since Roger Rubin was Treasury chief during the Clinton Administration. Mr. Snow’s predecessor, Paul O’Neill, also sought to stick to the strong-dollar mantra during his tenure, but only after he caused market jitters by failing to do so and came across as ambivalent.
Earlier in the global session, the euro shot up on Mr. Snow’s comments, briefly flirting with the $1.10 level, an area not seen in four years. The dollar hit a fresh low against the Swiss-franc at 1.3262 Swill francs, it weakest level since late 1998. The comments also helped undermine ongoing efforts by the Bank of Japan to weaken the yen through covert intervention in the currency markets. The dollar hit a global session low of Y117.04.
A quasi-retraction by Mr. Snow during the New York trading day helped reverse the losses somewhat. At a signing ceremony to collect his signature for use on new paper money, M. Snow repeated that he is in favor of a strong dollar. “Let me reiterate my support for the strong dollar,” he said, declining to take questions from reporters.
Analysts said the reaction to Mr. Snow’s remarks underscored the current volatile trading conditions. They also argued that Mr. Snow shouldn’t make such comments, unless he wants to signal a change in the Bush administration’s support for a strong dollar.
“If you have nothing new to say, then your best strategy is to say nothing,” said Marcel Kasumovich, head of G-10 currency strategy at Merrill Lynch, in New York, “Nobody forced him to say anything about the state of the dollar.”
To be sure, the weak dollar cannot be solely pinned to the new Treasury secretary. “The market certainly is using him as an excuse,” said Thomas Molloy, currency trader at Bank Leumi in New York.
The initial remarks may have sparked the downturn, but the speed and magnitude of the dollar’s fall had more to do with technical factors and broader problems facing the beleaguered greenback. “the dollar has been weakening since January of last year and at each step along the way, a new catalyst is identified” to explain the most recent movement, sad Paul Podolsky, chief currency strategist at Fleet Boston Financial in Boston.
“The bigger theme is there is just not enough demand for dollars right now,” he said, citing loose monetary policy, low interest rates and the possibility of a U.S.-led war with Iraq as factors inhibiting investment in U.S. assets.
During Wednesday trading, the steady drumbeat surrounding a potential military conflict in the Middle East failed to elicit much market response as traders shrugged off declarations from officials on both sides of the debate as more of the same.
France, Germany and Russia, who have repeatedly voiced their opposition to a military solution, said in a joint statement that they will vote against a second U.N. resolution on Iraq. The U.K., the U.S. and Spain have proposed a draft resolution that says Iraqi President Saddam Hussein has missed his final opportunity to disarm.
Meanwhile, U.S. Secretary of State Colin Powell rejected the European bloc’s call to give inspectors more time and resources before deciding on war. As long as Mr. Hussein is determined to hide his weapons of mass destruction, these efforts will not work, Mr. Powell said.
Chief weapons inspector Hans Blix for his part offered little new insight into Iraqi compliance to destroy its weapons of mass destruction, but did say the destruction of the illegal Al Samoud 2 missiles represents “real disarmament.”
Elsewhere, some of the currency market’s focus was on monetary policy, with both the European Central Bank and Bank of England to meet to decide on short-term interest rates. Strategists expect the ECB to slice rates by as much as 0.50 percentage points to 2.25%, while the BOE is expected to leave policy unchanged at 3.75%.
On Tuesday, the Bank of Canada raised interest rates 0.25 percentage points, while the Norwegian central bank eased rates by 0.50 percentage points earlier Wednesday.
Questions:
1. Carefully develop the exchange-rate model discussed in your text and class. Be sure to explain the underlying economic logic of the model by discussing how the equations relate to the graphical model.
2. Using the graphical exchange-rate model, show the impact of the major events discussed in the article on the exchange rate of the U.S. dollar. You may need a separate model for each event.
3. How quickly will the events discussed in the article change the value of the dollar? Explain. Does the article discuss any events that support your argument?
4. Read the Currency Markets column in the Wall Street Journal for two weeks. Choose one or more of the columns and answer questions (2) and (3) from above for each of the columns. You must have at least three events in addition to those found in the attached article that cause the exchange rate to change.