[LFX]

We have had a set of ECB officials emphasizing how important it is for the USD to be strong and for the US to say so. While it is difficult to keep track of all the formulations that have been used, there is some intensity to the way the ECB officials are calling for the US to repeat its strong dollar mantra, and ECB President Trichet may have broken some new ground yesterday when he stated that "It is extremely important that we can have a strong dollar," which implies that it is a European priority, as opposed to being just a US priority.

At the moment, it is pretty clear that a strong USD is in Europe's interests, but is it really in the US interest. One way to assess the desirability of a strong USD is to see whether USD weakness is correlated with rising bond yields. When it is, one might argue that the narrow gains from USD weakness are likely to be offset by losses from higher yields. There are times when the USD and rates move in the same direction, so a weaker USD is associated with lower rates – very desirable from a macroeconomic stabilization viewpoint.

We are now in the "strong USD not desirable" state, so while the Europeans may be able to get some pro forma comments from the US, there is reason to doubt the sincerity of them.

Most of the time, it seems to be the case that the USD operates in the "weak USD is in the US's interests" zone (and this is confirmed by more formal correlation analysis). So perhaps it is not surprising that the USD has been in long-term decline.

Moreover, the G20 statement on resolving imbalances seems to endorse the weak USD view. If US savings rises, something has to crowd in demand for US goods and services, and implicitly that is a weaker USD.