The Dollar's Big Comeback/No title
Jude Wanniski & David Gitlitz
August 16, 1995



The forces behind the dollar's surge to within sight of 100 yen continue to elude the financial press and most market observers. We have been suggesting for more than four months that the dollar's recovery from its low of Y81 was entirely dependent on the Bank of Japan's action to terminate the deflation which it caused in the first place. The BoJ first started doing this in halting dribs and drabs, which put the dollar within striking distance of 90 yen. In the last two weeks, since signaling its intentions to the Finance Ministry ('The Bank of Japan Gets On Board," August 2, 1995), it has moved aggressively to reliquify the banking system, and is now seeing the results.

The coordinated intervention carried out yesterday morning by the Federal Reserve, Bank of Japan and Bundesbank is being heralded as a masterpiece of shrewd central bank market execution and cooperation. But the dollars drained from the market by the New York Fed's international operations desk were replaced within hours by the domestic desk. Similarly, the deutschemarks injected by the Bundesbank yesterday were drained today. In other words, the Fed/Bundesbank intervention had no real affect on the availability of marks vis-a-vis dollars. This is the central banker's normal "sterilized intervention" shell game, an effort to move markets in the direction desired by the monetary authorities without actually changing policy. Aside from catching off guard the unlucky speculators who happen to be positioned the wrong way at the wrong time, these operations rarely if ever have lasting impact. Today, the dollar/DM rate is already running out of steam from yesterday's intervention, trading around DM1.4795, up only marginally from DM1.4778 at yesterday's New York close and down from DM1.4860 overnight. The only reason it's up at all against the mark is that traders are wary of being caught short in another official intervention.

Against the yen, however, it is a different story. Not only is the dollar holding all of yesterday's gains when it climbed from Y93.65 to Y96.94, it's still rising, buying about 97.85 yen in New York today (although it closed slightly above Y98 in Tokyo, and briefly touched Y99). The difference is that the BoJ has not sterilized its interventions, using them instead as a primary device to inject yen liquidity and break the deflation which has been crippling the Japanese financial system. Our assessment that the end of the yen deflation is now at hand is bolstered by the Nikkei stock index breaking through 18,000 for the first time since February and the 10-year Japanese Treasury yield rising to 3.275%, a rise of 18 basis points on Wednesday alone. The yen price of gold is also now comfortably above 35,000, heading briskly towards the Y38,000 level where it started the year.

The positive impact of the yen reflation on the market for dollar liquidity can be seen in gold dropping today by some $3 per ounce to below $383. The dollar's rise and gold's fall gives Fed Chairman Alan Greenspan the latitude he needs should he choose to use it to push through another much-needed cut in the federal funds rate at next week's FOMC meeting.

David Gitlitz

BUDGET TRAINWRECK: Speaker Newt Gingrich seems to have given a go-ahead to his troops to set up an October 1 "trainwreck" over the debt ceiling. There is still time for him to reconsider, as this is probably not the best Republican option. The voters are cynical enough about too-clever-by-half political stratagems from the Beltway Boys. The "debt ceiling" is the silliest vehicle around, and whether the Republicans "blink" or "don't blink," they will epitomize gridlock by even threatening to close down the federal government. There are sober voices suggesting a quick vote on the debt ceiling to get it out of the way in favor of a more compelling strategy. This is because Republicans are in a much more favorable position on the appropriation bills than they seem to realize. In the past, when appropriation bills failed, the government agencies involved would be financed via continuing resolutions at high levels of spending. Now, the President is faced with a nasty choice if he vetoes the appropriation bills prior to October 1 on the grounds that the GOP is too stingy. He makes his point, sure enough, but the rule is that the continuing resolution then passed in lieu of an appropriation must take the lower of the amount passed by the Senate or House. This means a veto produces even more stringency than the President desires. Putting the debt ceiling issue aside would permit this more interesting play of forces to develop later in the year, when budget reconciliation (and the tax cuts) arrives center stage. Gingrich would be in a much stronger negotiation position simply by going with the flow.

BRADLEY CALLS IT QUITS: New Jersey Democratic Sen. Bill Bradley will not seek a fourth term. This opens the door to Rep. Bob Torricelli, who had told Bradley he would run for the Democratic Senate nomination if Bradley did not. Torricelli, one of the most controversial Democrats in the Congress, has been itching to rebuild the national Democratic Party as a growth-and-opportunity party in the style of John F. Kennedy. He campaigned for the chairmanship of the Democratic National Committee after the GOP's sweep last November, losing to Sen. Chris Dodd of Connecticut, who remains rooted in the New Deal and its reliance on class warfare. Torricelli's liberalism is of the rising tide lifts all boats variety, most clearly identified with his outspoken advocacy of reduced taxation on capital gains. At Polyconomics annual client conference in March 1995 at Boca Raton, Fla., Torricelli wowed a very skeptical audience with an off-the-cuff reconnaissance of the world at large that could almost have been given by Jack Kemp. In fact, Kemp was the first in the audience to jump to his feet with applause, telling Torricelli: "You're too good to be in the Democratic Party." The comment came a week after Rep. Charles Rangel [D-NY] told Kemp on Meet the Press: "Jack, you're too good to be in the Republican Party." Torricelli's emergence could be the catalyst to propel the Democratic Party into long-overdue ideological reforms, which will force the Republican Party to cast loose from its Herbert Hoover budget-balancing anchor if it hopes to become the party identified with entrepreneurial capitalism.

BOSNIA WATCH: We continue to believe the participants in the Balkan civil war are getting bone-tired from the fighting, each disgusted with their allies. This usually is evidence that the balance-of-forces is congealing toward resolution. The international press in recent weeks has been portraying the Serbs of Krajina in a favorable light relative to the Croatians. The Bosnian Serbs have been expressing anger at the Serbian leaders in Belgrade, which increases the credibility of Serb President Milosevic as a peacemaker. In today's New York Times we discover a schism among the Bosnian Muslims. Prime Minister Haris Silajdic is now fighting those leaders of his own party, including President Alija Izetbegovic, who want to turn Bosnia into a one-party Muslim state, with Bosnian Serbs and Croats cleansed of political power. We have been warning on this point for years, as Izetbegovic has never made it a secret that he wishes Bosnia to be a religious state. You have not read this elsewhere, until now, because it has been inconvenient to those Cold Warriors who want to contain the Serbs, traditional allies with Moscow, and have used the "ethnic cleansing" propaganda to rally public opinion to the Muslim side.

Jude Wanniski