Dollar is ravaged as Fed goes to zero interest rates

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The dollar has been thrown to the wolves by the Federal Reserve’s decision Tuesday to slash its benchmark short-term interest rate to as low as zero.

Do Fed policymakers care about the greenback’s fate? For now, they obviously don’t.

The dollar was ravaged in currency trading today, particularly against its major rival, the euro. The European common currency soared to a 12-week high of $1.442, up from $1.398 on Tuesday and $1.271 two weeks ago.

The dollar also plunged to a new 13-year low of 87.24 yen, from 89.35 on Tuesday and 93.30 two weeks ago.

Currency values often are a function of countries’ interest rates, and with the U.S. now at zero on short-term rates, global investors can find better returns on their cash almost anywhere else. That’s a potential drain on the dollar as money shifts elsewhere.

The European Central Bank’s benchmark rate is at 2.5%. Canada’s is at 1.5%. Even Japan’s, at 0.3%, is higher than the Fed’s target range of zero to 0.25% for its key rate.

‘Japan no longer has the lowest-yielding currency in the industrialized world. It’s the U.S.,’ said Kathy Lien, head of currency research at GFT Forex in New York.

OK. But a currency’s value also is supposed to be a function of a country’s economic outlook. And it isn’t as if the European economy is looking swell for 2009.

Other than U.S. interest rates, ‘Nothing fundamentally has changed’ in the global economy, said Win Thin, senior currency strategist at Brown Bros. Harriman & Co. in New York. ‘There are bad numbers everywhere.’

In fact, some economists believe Europe is at risk of a needlessly ugly recession in part because the European Central Bank has been relatively slow to cut interest rates.

‘I think European policy is on the wrong page,’ Thin said.

But for the moment, the Fed’s move offers traders a great excuse to take profits in the dollar after its sharp rally of the last five months. The euro had plunged as low as $1.24 in mid-November, from nearly $1.60 in July, as global investors rushed into the dollar as a safety play.

Is a debased dollar a bad thing? It threatens higher inflation, eventually, because we have to pay more for foreign goods (and to travel overseas). So it makes us poorer as a nation, to be sure.

And that gives investors more of a reason to distrust paper currencies in general -- which is why gold has surged this week. Near-term gold futures rose $25.80 to $867.50 an ounce today in New York, the highest since early October.

But with the Fed battling severe deflationary head winds as the economy sinks, a weak dollar is the least of its problems for now. If the Treasury were having trouble selling its debt because foreigners were balking at dollar-denominated securities, a falling buck might be an issue. But as everyone knows, Treasury bond yields are at or near generational lows.

What’s more, you won’t be hearing any complaints from U.S. manufacturers about a sliding dollar, because their products are getting cheaper abroad. ‘A weak dollar will be one of the key factors that will pull the U.S. out of its slump,’ Lien said. ‘Any central banker fighting a recession will want a weak currency.’

Still, the risk with any currency debasement is that it won’t stop just because central bankers have decided that enough is enough.

-- Tom Petruno