Factors behind the dollar's surprising strength

The dollar has been up 19% against the euro and 24% against the British pound since July. What’s driving up the dollar? Businessweek provided three factors behind the dollar move.

Fear Factor

During tough economic times, investors often flee foreign currencies and other risky assets for safe havens like the U.S. dollar. The demand drives up the price relative to other currencies.

Foreign Economic Pressures

The euro, the pound, and emerging-market currencies may also have been inflated after a six-year runup…

… But earlier this year some investors started betting the bubbles would burst, driving down the price of the currencies and conversely benefiting the dollar.

Fund Redemption

U.S.-based hedge funds and mutual funds that own international stocks have played a part as well. Both groups are getting hit with a wave of redemptions. Investors yanked $39 billion out of international stock funds run by U.S. firms through the first nine months of the year…

… managers have had to dump foreign assets and buy U.S. dollars to pay back investors. Those purchases boost the greenback.

U.S. economy worse than first estimated

The U.S. economy, measured by gross domestic product (GDP), contracted at a seasonally adjusted 0.5 percent annual rate in the third quarter, the Commerce Department reported Tuesday. Originally, the government had estimated third-quarter 2008 GDP fell 0.3 percent. Second-quarter 2008 GDP climbed 2.8 percent.

The revisions to real gross domestic product were largely due to weaker consumer spending. It was the weakest performance since a 1.4 percent contraction in third-quarter 2001 GDP.

GDP is a measure of all goods and services produced in the economy.

The data revisions showed third-quarter spending by consumers fell 3.7 percent, down from a previously estimated 3.1 percent decrease. The 3.7 percent decrease took 2.69 percentage points from GDP in the third quarter. Consumer spending accounts for about 70 percent of economic activity.

Too big to fail: Government rescues Citigroup

U.S. government agreed to rescue Citigroup by shouldering as much as $306 billions in possible losses of troubled assets of the stricken bank and to inject a fresh $20 billion into the company. The agreement also gives the government control of executive bonuses and places limits on dividend payments. This move was announced late Sunday by the Treasury Department, the Federal Reserve and the Federal Deposit Insurance Corp.

The Rescue Plan

The $20 billion cash injection by the Treasury Department will come from the $700 billion financial bailout package. The capital infusion is on the top of an earlier one of $25 billion provided to the Citigroup in which the government also received an ownership stake.

Treasury and the FDIC will guarantee against the "possibility of unusually large losses" on up to $306 billion of risky loans and securities backed by commercial and residential mortgages. Citigroup Inc. will assume the first $29 billion in losses on the risky pool of assets. Beyond that amount, the government would absorb 90 percent of the remaining losses, and Citigroup 10 percent. Money from the $700 billion bailout and funds from the FDIC would cover the government's portion of potential losses. The Federal Reserve would finance the remaining assets with a loan to Citigroup.

The government will get $7 billion in preferred shares of Citigroup with an 8 percent dividend in exchange for the guarantees.

Citi will also issue warrants to the U.S. Treasury and the FDIC for about 254 million shares of the company's common stock at a strike price of $10.61.

As a condition of the rescue, the government must approve all executive compensation, including bonuses. In addition, Citigroup is barred from paying quarterly dividends to shareholders of more than 1 cent a share for three years unless the company obtains consent from the three federal agencies. The bank is currently paying a dividend of 16 cents, halved from a 32-cent payout in the previous quarter. The agreement also places restrictions on executive compensation, including bonuses.

The agreement calls on Citigroup to take steps to help distressed homeowners. Specifically, Citigroup will modify mortgages to help people avoid foreclosure along the lines of an FDIC plan that was put into effect at IndyMac Bank, a major failed savings and loan based in Pasadena, Calif.

The rescue plan represents the first time the government has absorbed bad assets rather than injecting money directly into financials. Switzerland's government recently crafted a similar agreement with UBS AG.

Too Big to Fail

Citigroup is too big to fail because it is such a large, interconnected player in the financial system. The company, with some 200 million customers, has operations stretching around the globe in more than 100 countries.

The government action is aimed at shoring up a huge financial institution whose collapse would wreak havoc on the already fragile financial system and the U.S. Economy. Citigroup failure would have seized up still fragile lending markets and caused untold losses among institutions holding debt and financial products backed by the company.

The action is the latest in a string of high-profile government bailout efforts. The Fed in March provided financial backing to JPMorgan Chase's buyout of ailing Bear Stearns. Six months later, the government was forced to take over mortgage giants Fannie Mae and Freddie Mac and throw a financial lifeline to insurer American International Group.

Citigroup was especially hard hit by the meltdown in risky, subprime mortgages made to people with tarnished credit or low incomes. Foreclosures on those mortgages spiked, leaving Citi and other financial companies wracking up $20 billion losses over the last year on the soured investments. The company has failed to turn a profit during the past four quarters and has announced plans to slash thousands of jobs.

A year ago, the stock market valued the company at about $180 billion. As of Friday morning, its market capitalization stood at $20 billion and its share price had shriveled to $3.75, a 16-year low.

Citigroup shares has plunged 60 percent of their value in the past week to a 16-year low, reflecting a crisis of confidence among skittish investors. They are worried all the risky debt on Citigroup's balance sheet will turn into losses as the economy worsens and the markets stay turbulent.

Market After Closing Bell

U.S. stocks Monday rallied for a second consecutive day after the government agreed to rescue Citigroup Inc. and as President-elect Barack Obama directed his new economic team to get to work.

Citi shares closed up 58%, at $5.94. Financial stocks in the S&P 500 posted their biggest one-day percentage gain ever on Monday, closing up about 17%. The Dow Jones Industrial Average, of which Citi shares are a component, rose 5%, extending Friday's late rally.

Useful finance and economic links: Dollar community on mixx, Money and Economy group on Ma.gnolia, smartinmoney.blog

Oil Prices Fell to 20 Month Low

Oil prices dropped on Tuesday to their lowest level in 20 months, since March 2007, as one of the worst economic slowdowns in recent months continued to slower consumption around the world.

Light, sweet crude oil futures for December delivery on the New York Mercantile Exchange settled at $59.33 a barrel, down 5 percent. Prices have plummeted 59 percent since hitting their summer peak of $145.29 a barrel in July.

Oil demand in the United States dropped over the summer after gasoline prices soared above $4 a gallon earlier this year. Since July 4, gasoline prices have dropped for 17 weeks, to a nationwide average of about $2.22 a gallon, according to AAA, the automobile club.

At an emergency meeting last month, the Organization of the Petroleum Exporting Countries (OPEC), whose members account for 40 percent of the world’s oil exports, agreed to reduce their output, as of Nov. 1, to slow the price slide. So far, OPEC producers have announced cuts totaling about 1.1 million barrels a day, less than the 1.5 million barrels a day that the cartel agreed to last month.

The world is facing the prospect of a simultaneous global recession for the first time in more than 60 years. The Chinese economy, long the main engine of growth in oil demand, is also slowing. Oil specialists now expect global demand to drop this year, which would be the first annual decline since 1983.

10.1 million Americans unemployed in October

Unemployment rate zooms to 14-year high of 6.5 percent in October

The U.S. unemployment rate jumped to a 14-year high of 6.5 percent in October, up from 6.1 percent just a month earlier, as 240,000 jobs were lost, the Labor Department reported Friday. The 6.5 percent jobless rate matched the rate in March 1994 after surpassing the last recession high of 6.3 percent seen in June 2003. About 10.1 million people were unemployed in October, the highest figure in a 25-year period since the fall of 1983.

U.S. nonfarm payrolls fell by 240,000 in October following a revised decline of 284,000 in September, which was the largest job loss in seven years. October's decline marked the 10th straight month of payroll reductions. So far in 2008, a total of 1.18 million jobs have vanished, with 651,000 coming in just the past three months.

This continuing worsen employment situation is a result from the economy's woes. A housing collapse, mounting foreclosures, hard-to-get credit and financial market upheaval have severely battered the U.S. economy and dragged the economy into unofficial recession. The economy has contracted at a 0.3 percent pace in the July-September quarter. The Federal Reserve last week ratcheted down interest rates to 1 percent and left the door open to further reductions to prevent the country from sinking into a deep and painful recession.

As U.S. consumers watch jobs disappear, they would cut spending even further, spelling more trouble for the sinking economy. As a result, the economy is predicted to keep shrinking until the first quarter of next year and the jobless rate may climb higher next year.

In the 1980-1982 recession, which is considered the worst since the Great Depression in terms of unemployment, the jobless rate rose as high as 10.8 percent in late 1982 just as the recession ended, before inching down.

Wall Street revived somewhat after two days of big losses. The Dow Jones industrials rose 248 points.

Bank of England & ECB cuts rates to fight recession

The Bank of England cut its key rate by an unexpected 1.5 percentage points Thursday to 3 percent, its lowest since 1955. Markets had largely factored in a cut as large as 75 basis points, while most economists had expected half-point cut in anticipation of deep recession. The move by the bank's nine-member rate-setting Monetary Policy Committee follows a decision last month to join in a global round of rate cuts by major central banks.

It is the most dramatic cut since a 2 percentage-point reduction in 1981 and comes after a raft of weak economic data recently. And it is the first time the Bank has cut rates by more than half a percentage point since gaining its independence in 1997.

Later Thursday, the Frankfurt-based European Central Bank slashed its key lending-rate by half of a percentage point to 3.25 percent.

Deflation Threat Is Real As Inflation Begins to Fall

Amid a progressively weaker economy and the financial crisis, the threat of deflation becomes a concern as inflation begins to fall. Deflation is caused by a sustained drop in overall demand and falling prices that forces businesses to cut prices ever deeper. It was last seen in the U.S. in the 1930s and in Japan in the 1990s, when the inflation rate fell to zero and then turned negative for several years.

The most recent figures show all of the factors that fueled earlier inflation worries have sharply reversed course.

Consumers are retrenching their spending at a 3.1 percent pace, the first decline in 17 years and the sharpest quarterly drop since the second quarter of 1980. Consumer confidence hit an all-time low of 38 in October, the lowest reading ever recorded since the survey began in 1967.

Job and wage growth are weakening at faster rates. Unemployment is expected to rise from its current level of 6.1 percent.

The stronger dollar is pushing down import prices as well as crude-oil and other commodities prices. The 15-nation Euro last week fell to its lowest level against the dollar since April 2006 while the pound at one point last week lost a staggering 8 cents against the dollar, the biggest intraday move since exchange rates became freely floated in 1971.

Oil prices have plunged spooked by the dim outlook for the U.S. economy. Oil fell 33 percent in October, a record monthly decline, settled at $67.81 a barrel at 2:52 p.m. on the New York Mercantile Exchange. Oil has fallen by 54 percent since reaching a record $147.27 on July 11 and now is down 28 percent from a year ago. Cheaper oil will magnify the coming slide in overall inflation.

Even excluding oil, commodity prices have collapsed. The Reuters/Jefferies CRB Index of 19 raw materials plunged to 256 on Oct. 24, the lowest since Sept. 8, 2004. The gauge had lost more than 40 percent since reaching a record at 473.52 on July 2 as the credit crunch choked worldwide growth.


Asset-price deflation is especially corrosive. The Dow Jones industrial average fell to 9,325.01, or 14.1 percent in Oct, the worst month for the blue-chip benchmark since August 1998. The Dow has fallen 34 percent since its last peak in Oct 2007. The broader stock index S&P 500 dropped to 968.74, or 16.8 percent in Oct, worst month record in 21 years. Since its last highest close in Oct 2007, the S&P has plunged 38 percent.

The Standard & Poor's Case-Shiller Home Price index is down 20 percent.

Asset-price declines are part of a broad deleveraging by financial firms and households. This forced reduction of debt is fueling the sale of homes, stocks, and other securities at heavily discounted prices. The process has been shutting off new lending in a self-reinforcing spiral that destroys wealth and depresses demand. The destruction of this deleveraging process makes this business cycle even more susceptible to deflation.

Yearly consumer inflation peaked at 5.5 percent in July but is set to fall to close to zero by early next year. Still, prices outside energy and food will determine whether broader inflation may be falling too rapidly.

Deflation is burdensome for borrowers. As prices are falling, borrowers have to pay back loans in dollars that will buy more goods than the dollars when they borrowed. Deflation also raises the real, or inflation-adjusted, cost of borrowing because policy makers cannot cut the target rate below zero. At that point, negative inflation is counterproductive as it keeps the real rate high enough that restrict efforts to boost spending and economic growth.