Inside Investment: Doomwatch
Sub-prime slime and the credit crunch have diverted attention from global imbalances. However, any dollar rout would be ugly. Neglect is no substitute for policy.
On the 20th anniversary of Black Monday last month, there was much prognostication and opining from soi-disant market sages. Comparisons between equity markets then and now are wide of the mark. However, wind the clock forward five years from 1987 and look at currencies rather than equities and the parallels are compelling.
The last time before this year that the DXY index, which measures the strength of the dollar against a basket of other currencies, fell below 80 was September 1992. Germany was experiencing a post-unification boom and the US was fighting a recession. On Black Wednesday (September 16) both the pound and the Italian lira fell victim to the mighty Deutschemark and were forced out of the European Exchange Rate Mechanism.
We are now living through another period of profound currency market misalignment.
At the root of most of the evils are global imbalances. The US current account deficit is 5.5% of GDP. At the same time, Asian economies, most dramatically China, are accumulating foreign exchange reserves. China had reserves of just $50 billion in 1994.