From December 1993 to March 1995, the dollar lost 23% of its
value against the Swiss franc. It then turned around and, in
fits and starts, gained 11% in the following months until July
1996. In mid-July, jitters in Wall Street spread to currency
markets and abruptly halted the dollar's slow-p[aced appreciation
against the Swiss franc. The dollar fell from Sfr. 1.26 to Sfr
1.22 in a week, wiping out the dollar's gains of the past five
This nervous reaction marked a change in sentiment.
Previously, any signs of a buoyant U.S. economy would wreck havoc
on equity and bond markets but would help boost the dollar. This
time, bad news for Wall Street translated as bad news for the
U.S. currency. And despite a subsequent recovery in Wall Street,
the dollar remains in the doldrums. As uncertainty continues
over the health of dangerously inflated U.S. equity markets,
investors and traders could be persuaded to unwind equity and
Another stress point for the dollar in recent weeks has been
in regard to potential increases in Japanese interest rates.
Easy monetary conditions to spur the Japanese economy and heavy
buying of dollars by the Bank of Japan, some $20 billion in the
first quarter of 1996, helped support the greenback. In May,
Japan's foreign currency reserves rose to $207 billion or an
increase of 33 percent from a year earlier. But Japan's appetite
for dollars may be reaching satiation levels. As the economy
recovers, the BOJ will be less inclined to intervene on behalf of
the dollar, and by extension, Japanese export industries. If
trade relations should sour, the dollar would have to live
without Japan's crucial support.
Nor can the U.S. count on Germany. Bundesbank officials
have stopped talking about an undervalued dollar, in part because
attention has turned to worries over the European Monetary Union
and weakness in the French franc. But stronger than expected
growth in the economy may bring the Bundesbank's period of easy
monetary policy to an abrupt close.
Under these circumstances, structural weaknesses in the U.S.
currency would reassert their influence on the dollar's exchange
rate vis-a-vis the "hard" currencies. America's inflation rate,
which tends to be higher than in Japan, Germany or Switzerland,
will erode the dollar's purchasing power in relation to those
countries' currencies in the long run. Chronic U.S. current
account deficits resulting from Americans' high propensity both
to consume and to import goods also tend to keep the dollar
undervalued. Given that Americans import proportionately more
than Japan, Germany or Switzerland, import prices need to rise
(the dollar remain cheap) in order to keep the deficit at
The upswing in the U.S. economy has already resulted in
larger trade deficits. The trade deficit in April 1996 has
widened to $16.5 billion compared to $14.7 in the same period
last year. Credit Suisse Research estimates the amount needed to
fill the financing gap in the U.S. current account for 1996 to be
around $130 billion, or not much below that for 1995. Last year,
foreign central banks funded three-quarters of the deficit
through dollar purchases. If central banks are less inclined to
buy dollars this year, the question remains: who will fund the
In the weeks and months ahead the dollar's fate will be
influenced by the performance of the Japanese and German
economies and developments in U.S. asset markets and external
balances. There is plenty of potential for bad news on these
fronts to trigger a rush to safety and quality. Potential
turbulence in the run up to a single currency in the European
Union may or may not help the U.S. dollar. The Swiss franc,
however, would remain a significant beneficiary of greater
perceived risks in Wall Street and in the U.S. currency.
Rosanna Arguelles is with the firm of
JML Swiss Investment
Copyright © 1996 by JML Swiss Investment Counsellors.
The Investor's Library has reprinted this copyrighted article with the permission of the copyright owner.