The nomination of Henry Paulson as U.S. Treasury secretary is seen as a boon for financial markets, but the Wall Street free-marketeer is unlikely to stand in the way of the falling dollar.
The depth of the U.S. current account deficit is such that financial markets increasingly believe this fundamental root of widening global imbalances will adjust only if the dollar weakens.
Having the market-savvy chief executive of Goldman Sachs at the helm of the world’s largest economy instead of John Snow, often seen as more of a cheerleader for the White House’s economic policies than a policy-maker himself, could lend confidence to Wall Street’s perception of the Bush administration. But it won’t be enough to prop up the dollar.
“Financial markets do typically like it when a Wall Streeter takes a key role in the administration,” said David Mozina, head of foreign exchange strategy with Lehman Brothers in New York.
“It could be modest positive for the dollar, but still, with what has been thrown at the dollar, it’s not going to be allowed to have a respite for too long,” he said.
The dollar has tumbled 2.6 percent since late April after central bankers and finance ministers from the Group of Seven rich nations agreed more must be done to alleviate imbalances, including further strengthening of the Chinese yuan.
The G7 meeting, coinciding with what many observers believe to be the near end of the Federal Reserve’s campaign of rising interest rates, was pivotal because it sparked the resumption of the dollar’s multiyear decline after a halt in 2005.
Despite the impression that Paulson may be a steward for a stronger dollar, he is on record saying the dollar has to decline to restore balance to the U.S. current account deficit. Last year, the deficit grew to more than 6 percent of gross domestic product.
In a U.S. public television interview two years ago, Paulson said, “I’m concerned about the current account deficit, but I would say by order of magnitude, I’m more concerned about the budget deficit than the current account deficit because I really believe that the decline in the dollar — the orderly decline in the dollar — will lead to a natural adjustment.”
Paulson, who told the Wall Street Journal in April that he has visited China 70 times since 1990, is expected to keep up pressure on the world’s fastest-growing economy to allow the yuan to strengthen more, which traders equate with a weaker dollar.
“Paulson will drive home the fact that the dollar needs to be weaker against the Asian currencies specifically,” said a senior dealer with an asset management firm.
RUBINOMICS REPLAY?
In nominating Paulson to the top Treasury job on Tuesday, President George W. Bush said the Goldman Sachs chief will “help ensure that our trading partners … maintain flexible, market-based exchange rates for their currencies.”
While the dollar could continue to decline under Paulson, other assets might benefit from Wall Street’s positive reception of him at the Treasury.
“I think we are going to get a chance for Rubinomics,” said Michael Cheah, vice president and portfolio manager with AIG SunAmerica Asset Management in Jersey City, New Jersey.
Rubinomics is an informal term used to describe economic policy in the mid- to late 1990s under former Treasury Secretary Robert Rubin that included fiscal restraint and the use of “strong dollar” rhetoric.
“Rubinomics would start by reducing the budget deficit and that in turn would lower interest rates here, which should provide a strong underpinning for the Treasury market and the U.S. stock market,” Cheah said.
However, given that President Bush has only two more years in office and mid-term elections are in November, Paulson may serve more political ends than policy means.
“We believe that, on the margin, the move would be good for the U.S. economy because he knows financial markets and speaks Wall Street’s language,” said Michael Mayo, analyst with Prudential Equity Group in New York. “The move is probably intended to help the political administration going into upcoming elections,” he said.
After the G7 statement on currencies last month, the Treasury’s report on China that avoided the “currency manipulator” tag and the extension of tax cuts, Paulson may not have much leeway for concrete policy changes.
His nomination “might allow the dollar to come up for air, but it will basically be a gasp,” said Lehman’s Mozina.
(Additional reporting by John Parry)
© Reuters 2006
