What Happened to Bernanke's 'Plan' to Depress the Dollar?

Only a month ago, many commenters attacked Fed Chairman Ben S. Bernanke for trying to push down the dollar's value. But surprise! -- the dollar has actually strengthened against its major rivals since the Fed announced its plan to start buying Treasury bonds again as part of its second round of quantitative easing, or QE2. Of course, that may not please U.S. companies that were hoping for an export bonanza.

Bernanke began hinting as long ago as August that the central bank would launch QE2 , with the goal of forcing long-term interest rates lower and thus stimulating the U.S. economy.

But critics railed at the policy's likely impact on the dollar. Former Fed Chairman Alan Greenspan complained that America was "pursuing a policy of currency weakening." A group of conservative economists published an open letter in The Wall Street Journal warning that the asset purchases "risk currency debasement." Multimillionaire investor Jim Rogers said even his four-year-old daughter knew "they are debasing the currency."

More Talk of a Euro Crackup

The Fed announced QE2 on Nov. 3, but a funny thing quickly happened: Interest rates on long-term U.S. bonds, which are set by the market, started to rise, not go down. Likewise, the euro has fallen about 10 U.S. cents against the dollar in the interim. In fact, in just the past few days the euro has retraced about 50% of the gains it made in a rally that began in June.

The prime mover seems to be the uncertainty in Europe over the bailout of Ireland and the implications that rescue holds for other so-called peripheral European countries with dicey economies, mainly Spain and Portugal. The blogosphere was full of commentary Monday about how the euro is headed for a crackup, similar to language last heard in May, when the European Union and the International Monetary Fund had to ride to Greece's rescue.

"I think the dollar strength you've seen in the last two weeks has really been very closely related to the risk aversion driven by tension in Europe," says Jens Nordvig, global head of foreign exchange strategy at securities firm Nomura International.

Nordvig says Nomura now has a risk premium of about 11% on the euro, up from zero in the summer. That means without the current crisis in Ireland, the dollar would be trading above $1.50 to the euro. Instead, it's trading at about $1.31.

Additional Factors

Nordvig says the additional concern surrounding the tensions between North and South Korea has only added to the flight to safety. "That has stalled the trend toward dollar weakness versus Asian currencies, and it's reasonably clear that it has just added to the overall risk aversion and the flight into dollars again," Nordvig says.

Marc Chandler, global head of currency strategy at Brown Brothers Harriman, says the U.S. economy is another factor. "Europe is the larger driver right now, but I would not underappreciate that U.S. economic data has generally surprised on the upside for the past month," Chandler says. "Not only have German interest rates fallen, but U.S. rates have risen."

Chandler says he expects further declines in the euro: "The dollar is always a safe-haven currency, and I suspect there's more to come even though the euro has come down a long way already."

He says he had forecast that in the second half of the fourth quarter, he saw the dollar recovering as uncertainty around fiscal policy -- namely, the U.S. election results -- passed and U.S. economic data edged up.

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Nordvig says yet another factor supporting the dollar was the large number of investors who had short positions in the currency -- meaning they had bet that the dollar would go down. As they unwound those positions in late October, that had the effect of causing the dollar to rise, he says.

While the strengthening dollar is great for those planning a Christmas visit to Paris, it also has a downside: Many U.S. manufacturers had been counting on a cheaper currency to help them boost sales abroad, particularly in Asia, where they compete fiercely with European exporters.

President Obama has vowed to double U.S. exports in the next five years, but if the dollar continues to strengthen, reaching that goal will be increasingly unlikely.