Geithner gaffe roils markets

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By Patrice Hill

An unguarded comment by Treasury Secretary Timothy F. Geithner on Wednesday set off a sudden drop in the dollar and contributed to a chain of market-rocking events that included a setback in the stock market and a sharp uptick in interest rates.

Mr. Geithner appeared to lend his support to a proposal by China's central bank governor to replace the dollar as the world's reserve currency with a basket of currencies that would be managed by the International Monetary Fund. In an appearance before the Council on Foreign Relations in New York on Wednesday morning, Mr. Geithner raised eyebrows by saying that "we're actually quite open to that," only a day after both he and President Obama had vehemently rejected the idea and affirmed their strong support for the U.S. currency.

The dollar plummeted by as much as 1.3 percent against the euro within 10 minutes of his remarks. But then the greenback quickly recouped most of its losses after Mr. Geithner retracted his statement and said, "I think the dollar remains the world's dominant reserve currency." Later in the day, as concern weighed down the dollar again, White House spokesman Robert Gibbs chimed in to the now universal chorus from top officials that the administration expects the dollar to be the world reserve currency for "a long, long time."

But the damage may already have been done. By afternoon, a poor showing of buyers at a Treasury bond auction sent interest rates sharply higher, raising fears about the U.S. ability to sell a massive load of $2.5 trillion of debt this year. Buyers may have been spooked not only by the Treasury secretary's remarks but also by the unveiling of budget plans on Capitol Hill that would double the amount of debt the Treasury has to sell in the next five years to nearly $12 trillion.

"They are opening the spigots and flooding the market, and there is no end in sight to the deluge of supply" of Treasury bonds, said Louise Purtle, analyst at CreditSights.

"The poor communication from the Treasury Department has complicated the market for Treasuries," said Jeffrey Caughron, chief market analyst at the Baker Group investment firm.

The mounting worries about the debt also snuffed out a rally in the stock market that had been fueled by reports showing the U.S. economy may be stabilizing after a free fall this winter. The Dow Jones Industrial Average plummeted from a gain of nearly 200 points to a 108-point loss within minutes after Treasury announced the auction results. But by the end of a day of big swings in trading, muted optimism about the outlook for the economy had returned and enabled the Dow to eke out a 90-point gain.

The day of tossing and turning in global markets illustrated the risks for the Treasury secretary, who like his predecessors, has to be careful about what he says about the dollar as global markets follow his every word. It also shows the dangers for the United States as it goes deeply into debt to try to stimulate the economy out of a severe recession and rescue its ailing banking sector.

Mr. Geithner has tangled with markets before in his short two months in office, sparking a plunge in global stocks last month when he unveiled a bank cleanup plan that was vague and unconvincing, while spawning a nearly 500-point surge in the Dow on Monday when he offered a more detailed and credible plan.

James McCormick, Citigroup´s global head of foreign exchange, said he was surprised that Mr. Geithner expressed openness to the proposal by People´s Bank of China Governor Zhou Xiaochuan after acknowledging he had not read it. Mr. Zhou proposed creation of a "super-sovereign reserve currency" that is disconnected from any nation by increasing the use of special drawing rights at the IMF, a kind of currency the fund offers to its members.

"If I´m running the Treasury, I would want to have been briefed on that" before commenting on it, Mr. McCormick said. Markets have been particularly sensitive to any discussion of the Chinese proposal in the run-up to the Group of 20 meeting in London next week. IMF Managing Director Dominique Strauss-Kahn on Wednesday added his voice to the debate by calling the Chinese proposal "legitimate," although he said he doesn't expect the dollar to be replaced any time soon.

Investors were stunned by Mr. Geithner's remarks in light of a strong defense of the dollar given by Mr. Geithner and Federal Reserve Chairman Ben S. Bernanke on Capitol Hill on Tuesday. President Obama, in a Tuesday night news conference, also rejected calls for a new global currency in proclaiming that "the dollar is extraordinarily strong" because investors are confident in the ability of the U.S. to lead the world out of recession.

The value of the dollar is as important to global investors as it is to U.S. citizens, particularly those who buy Treasury bonds. Any fall in the dollar immediately erases some of the value of their holdings - a concern raised earlier this month by China, which is the biggest investor in Treasury bonds.

China and other investors recently have taken to worrying about whether the United States may debase its currency in its drive to address economic problems. Borrowing to counter the recession and finance the economic stimulus and bank bailouts is expected to peak at $2.5 trillion this year and start to decline under budget outlines offered by Mr. Obama and Congress. But investors worry about the lingering effects of the legacy of debt and the inflationary impact of the Federal Reserve's program to help finance that debt with $300 billion of Treasury bond purchases.

Apprehension about these matters is apparently what led to the Treasury's difficulty in selling $24 billion of five-year notes Wednesday afternoon.

To attract buyers, the Treasury had to pay interest rates that were significantly higher than its previous auction, touching off fears about the nation's ability to finance ever bigger loads of debt in the future.

It didn't help that Britain on Tuesday experienced its first failed bond auction in nearly seven years - a bad portent since Britain, like the United States, has gone deeply into debt to finance large economic stimulus and bank bailout programs. The poor showing came despite the Fed's move to help Treasury by purchasing $7.5 billion of the notes just before the auction.

But CreditSights' Ms. Purtle said the most serious problem the Treasury faces is the lack of buyers worldwide for its growing mountain of debt. In particular, countries like China and Japan that invested their trillions of dollars in export earnings in the Treasury market have been hit by plummeting exports, which means they have less money to invest in Treasury bonds, she said.

Also, nations that generated huge surpluses from exports of oil and other commodities, including Brazil, Russia and Saudi Arabia, were major buyers of U.S. debt during the commodity boom last year. But they now are earning much less on those commodities and have less money to invest, she said.

"Trade surpluses are being turned into trade deficits on the back of a global recession, and the funds simply aren't available to continue the purchases," she said.