Lending crisis causes spike in demand for dollars

Subprime-Infected Funds Drive Demand for Dollars (Update2)
By Matthew Benjamin and Liz Capo McCormick

Aug. 14 (Bloomberg) -- The dollar is no longer the currency you love to hate. Now, it's the currency you can't live without.

Last week's credit crunch has set off a worldwide rush for dollars as banks and fund managers scramble to pay back loans used to buy risky mortgage securities. They are competing with firms such as AXA Investment Managers, Investec Asset Management Ltd. and FX Concepts Inc., which are also buying dollars in a bet on further appreciation.

After a five-year tumble that took the U.S. currency to its lowest level in a decade, it has rallied 1.4 percent against the euro and 1.2 percent against the pound in the last three trading days. And it's ``likely to keep benefiting,'' said Mansoor Mohi- Uddin, head of currency strategy in London at UBS AG, the world's second-largest foreign exchange dealer.

The dollar's advance shows that, for all the talk of challenges to its primacy, it remains the world's go-to reserve currency in times of market turmoil. ``This is where people take refuge,'' said Komal Sri-Kumar, who oversees $145 billion as chief global strategist at TCW Asset Management Co. in Los Angeles. ``The dollar is still a safe-haven currency.''

The dollar rose against the euro as of 1:26 p.m. in New York, climbing to $1.3570, from $1.3613 late yesterday. The U.S. currency is up from $1.3798 late on Aug. 8 and a record low of $1.3852 reached on July 24. ``European banks are struggling to roll over their short-term financing,'' said Mohi-Uddin, whose bank accounts for 15 percent of the currency market, according to an annual Euromoney magazine survey. UBS predicts the dollar will gain to $1.32 per euro in three months.

BNP's Bombshell
BNP Paribas SA, France's biggest bank, spurred the stampede into dollars on Aug. 9 by halting withdrawals from funds invested in subprime debt. Just a week earlier, Chief Executive Officer Baudouin Prot said the Paris-based bank wasn't at risk.

While the credit-market turmoil originated in the U.S. as delinquencies rose on subprime mortgages -- those made to borrowers with poor or spotty credit history -- it has spread around the world. European banks are particularly at risk after borrowing in dollars to finance their investments, analysts said.

There is an ``increasingly visible presence of European names on the borrowing side'' of lending by U.S.-based banks, Wrightson ICAP economists wrote in an Aug. 13 report, citing their analysis of Federal Reserve data. Europe's rush for funds was aggravated because U.S. financial markets were closed at the hour of the BNP announcement, they wrote.

`A Liquidity Panic'
``The combination of time-zone complications and the regional imbalance in dollar funding requirements between the U.S. and Europe is a combustible mixture in a liquidity panic,'' the economists wrote. Lou Crandall, chief economist at Wrightson ICAP in Jersey City, New Jersey, declined to comment.

The overnight lending rate for dollars in Europe, the London Interbank Offered Rate, jumped to its highest in six years as investors and lenders sought cash to unwind bets gone awry. The European Central Bank pumped a record 94.8 billion euros ($129 billion) into euro-denominated money markets on Aug. 9, keeping most of that in the system the next day. The Fed injected $62 billion in the U.S. over the two days.

Besides BNP, German banks have also been hit. Germany's government had to organize a rescue package for IKB Deutsche Industriebank AG as the Dusseldorf-based bank unveiled potential losses of as much as 3.5 billion euros.

NIBC Holding NV, the Dutch investment bank owned by a group including J.C. Flowers & Co., said Aug. 9 it lost at least 137 million euros on U.S. subprime mortgage investments this year. The Hague-based bank said it expected further losses.

Short-Lived
The dollar's surge may be short-lived if credit concerns abate, analysts said. In that case, investors' focus is likely to return to a weakening American economic outlook and concern about reliance on foreign funds to finance record U.S. current-account deficits.
``On any risk aversion there is a return to safe-haven currencies, of which the dollar is the main one,'' said Thanos Papasavvas, head of currency management at Investec Asset Management in London, whose firm bought dollars ``across the market'' last week. ``This is mostly a closing down of risk positions which also caught the market short of dollars.''

The dollar will drop to $1.38 per euro by year-end according to the median forecast in a survey of 45 analysts by Bloomberg. It has declined 18 percent against the currencies of the main U.S. trading partners in the past five years, according to the Fed's broad trade-weighted index. It fell as low as 102.05 on July 24, the lowest level since June 1997.

Expecting Weakness
``If the U.S. economy continues to slow down relative to the rest of the world, and given the large U.S. current-account balance, I would expect the dollar to weaken further,'' said Nouriel Roubini, chairman of Roubini Global Economics LLC and a professor at New York University's Stern School of Business.

The International Monetary Fund forecast on July 25 that the global economy will expand 5.2 percent in 2007. The Washington- based fund predicted that both Japan and the 13-nation region of countries that share the euro will outpace the U.S., expanding 2.6 percent compared with 2 percent.

The deepening crisis in U.S. subprime mortgages and credit- market turmoil prompted Fed policy makers on Aug. 7 to acknowledge that ``downside risks to growth have increased somewhat.'' Defaults on subprime loans are at their highest in a decade, according to Friedman Billings of Arlington, Virginia, a real estate investment trust that owns most of investment bank FBR Capital Markets Corp.
Losses on subprime securities are also helping the dollar for now by leading some American investors to repatriate funds from abroad, analysts and investors said.

Kobe Earthquake
A similar pattern occurred in Japan after the January 1995 Kobe earthquake, which devastated the port located near Kyoto and killed 6,434 people. Japan's currency climbed more than 18 percent against the dollar in the three months following the disaster, boosted by Japanese investors and insurance companies bringing home foreign investments.

``At a time when U.S.-based portfolio managers are cutting risks, they tend to repatriate money back to the U.S.,'' said Lucio Sarno, London-based director of currency research at AXA Investment Managers, who helps manage $741 billion in assets. ``We've been buying dollars,'' he added, predicting ``near-term support'' for the currency.

While the dollar's share of global foreign-exchange reserves has fallen in recent years, it remains the predominant currency held by central banks. The dollar accounted for 64.2 percent of foreign-exchange reserves as of March, IMF data show. It made up 71.1 percent eight years earlier.

``For a long time there has been talk about the dollar is garbage,'' said John Taylor, chairman of FX Concepts, a New York fund that has been adding dollars among the $12.1 billion in currencies. ``The dollar is the king now.''