USD$ STILL UNDER VALUED?

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By John Fraher and Rainer Buergin

Nov. 7 (Bloomberg) -- The International Monetary Fund said traders are probably using the dollar to fund “carry trades” across the world and the currency may still be overvalued even after its slide this year.

“There are indications that the U.S. dollar is now serving as the funding currency for carry trades,” the IMF said in a report published today. “These trades may be contributing to upward pressure on the euro and some emerging economy currencies.” While the dollar “has moved closer to medium-run equilibrium,” it is still “on the strong side.”

With investors able to borrow at near-zero interest rates in the U.S., some economists are concerned that markets may become distorted as traders plough those funds into riskier assets. Nouriel Roubini, the economist who forecast the financial crisis in 2006, said Nov. 4 that investors are milking the “mother of all carry trades.”

The MSCI All-Countries World Index has gained about two- thirds since March and sugar has soared 90 percent this year. The dollar has dropped 13 percent against a basket of currencies from its major trading partners in the past seven months.

The euro’s exchange rate “is on the strong side of its equilibrium,” the Washington-based IMF said.

Chinese Currency

The fund, which published the report as officials from the Group of 20 nations gathered in St. Andrews, Scotland, also said that the yuan is “significantly undervalued.”

“The Chinese renminbi has depreciated in real effective terms in tandem with the U.S. dollar and remains significantly undervalued from a medium-term perspective,” the IMF said.

Chinese central bank Governor Zhou Xiaochuan told Bloomberg News yesterday that “the pressure from the international community to allow yuan appreciation is not that big,” deflecting calls from Europe and Japan to let it rise.

The IMF also said in its report that countries should withdraw economic stimulus too late rather than too early because the global economic recovery is likely to be “sluggish” and inflation rates will stay low.

“The timing of exits should depend on the state of the economy and the financial system, and should err on the side of further supporting demand and financial repair,” the IMF said.

More Support

The G-20 said today in a joint statement it had “agreed to maintain support for the recovery until it is assured.” While economic and financial conditions have improved, “high unemployment is a major concern,” the officials said.

Countries should coordinate the withdrawal of stimulus to avoid “adverse spillovers,” though that does not necessarily imply synchronization, the IMF said in a seven-point catalog of principles for policy exit.

Curbing government deficits should be a “top policy priority” while monetary policy can adjust more flexibly when “normalization” is needed, the IMF said. Central banks needn’t take back their unconventional policy measures before starting to raise interest rates, it said.

To contact the reporters on this story: John Fraher at jfraher@bloomberg.net; Rainer Buergin at rbuergin1@bloomberg.net

Last Updated: November 7, 2009 13:52 EST