Marking down the mark

In the Nov 4, 1996, issue of FORBES I recommended that the readers buy one-year 1.30 dollar calls against the Swiss franc at a price of I% to play for an impending rally in the dollar. Since the dollar has moved smartly from 1.25 SF/$ to 1.42 SF/$.

If you followed my advice, what should you do now? I believe that the fundamentals for higher levels are still very much in force, but the technical conditions are a bit shaky, so I suggest that you take prof­its on your original position at the current price of7%. Use some of your profits on this dollar call to ski in Gstaad.

My next target is the German mark. It is evident that Germany is experiencing many of the same negative conditions that beset Switzerland. Germany, too, is suffering from an overvalued currency that prices many of its products out of the.world market, and this has led to large-.scale unemployment. Germany faces an immediate need to kick-start its economy. Unless German growth rates can be raised above 2 1/2% per annum, the unemployment will be a serious problem for the ruling party in what is sure to be a bitterly fought general election in 1998.

There are very few tools remaining for the German authorities to implement in order to boost their economy. Running a larger budget deficit is out of the question at a time when Germany is striving to meet the Maastricht criteria for a common currency. At the same time, Bundesbank council members are reluctant to lower interest rates much further. Therefore, the only mechanism to, stimulate the economy is to weaken the deutsche mark. In short, the mark is coming down.

This weakening will occur broadly against most other European currencies as well as against the dollar. With the possible exception of the Swiss franc, the mark could very well be the weakest currency in 1997.

In a way, what we are witnessing is a mirror image of the deutsche mark appreciation of 1989-95 when financial institutions around the world bought hundreds of billions of marks in anticipation of a long-term German economic boom. Optimism was running at euphoric levels and German policymakers implemented a powerful prescription for a strong currency: tight monetary policy and loose fiscal policy.

In the fight against the German slump this prescription has been reversed, and the prospect of large-scale deutsche mark liquidations looms. Foreigners who bought the mark for its soundness and high interest rates will be selling their mark-denominated securities. The European Monetary Unit,(EMU) is looking more and more like a watered-down currency, and the rules and regulations of Maastricht practically ensure 'that the hardening of the EMU will be nearly impossible. The treaty is, in my view, a kind of collective lunacy that allows substantial government spending only when it is not required.

Furthermore, the prospect of the Brussels bureaucracy curbing the European Central Bank destroys the prospect of a strong, independent central bank. The long-term ramifications of these developments are enormous, but it is still too early to see exactly how this process will unfold.

What is clear, however, is that the German vision of creating a true single market devoid of currency risk is very different from the French vision of creating an EMU to counteract the dominance of the dollar.

In the meanwhile, Germany is progressively more committed to exporting its recession to its trading partners, and this strategy is shared avidly by the Swiss. The U.S., on the other hand, is happy to accommodate a depreciating mark. Our strong domestic economy benefits from the deflationary impact of a rising dollar. A strong buck allows the Fed to delay any potentially disruptive tightening decisions.

In time, the mark will strengthen again when the German economy finally picks up, but this is a long way off. Before that happens it is possible that the mark will overshoot on the downside and become far weaker than any of us would think reasonable.

For those FORBES readers who compete against German companies, this may spell trouble. It al.so spells trouble for American companies doing a lot of business in Germany who will get fewer dollars for their German profits. But for those willing to speculate in the currency markets, it looks like a great bet.

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