Shouldn’t the Dollar Be Appreciating More Sharply?

March 14, 2013

As post-financial crisis dust continues to settle, a number of U.S. currency value determinants are better than before, if not absolutely, then in relative terms.

Start with the current account.  Before the crisis, such widened progressively from 1.5% of GDP in 1993-96 to 2.9% of GDP in 1997-2000, 4.6% of GDP in 20013-04 and and 5.4% of GDP in 2005-08 the peak calendar year being 6.0% in 2006.  For the past four years, the deficit has averaged 3.0% of GDP, half the peak year’s relative size.  More importantly, it’s not only much better contained but in fact trending downward, having equaled 2.8% of GDP in the second half of 2012.

U.S. inflation remains low.  Core CPI inflation averaged 2.0% per annum over the past sixteen years including 1.9% in the year to January 2013.  Multiyear spans of dollar weakness in the 1970s, 1980s and 1990s tended to be characterized by a combination of current account deterioration and high relative inflation.  Widening fiscal deficits, in contrast, were not necessarily a weak dollar marker.  Public finances worsened sharply in the early 1980s, an episode of extraordinary dollar strength that saw the most elevated post-1971 dollar-mark level hit in February 1985.  In any case, the Federal government deficit has in fact been declining relative to GDP at a faster pace than analysts had predicted it would, and so has the unemployment rate.

Capital flow financing of the U.S. current account imbalance was qualitatively sounder last year than in 2011.  To be sure, official capital inflows totaling $454 billion were much more prominent in 2012 than 2011.  But top quality long-term private capital inflows, represented by direct investment and portfolio investment, improved considerably.  The net capital outflow of foreign direct investment in the United States set against U.S. direct investment abroad was $8.6 billion smaller, and six of the eight components of portfolio investment strengthened.  Foreigners purchased $77.8 billion more of U.S. equities, $38.0 billion more of agency bonds, and 17.2 billion more of corporate bonds than in 2011.  U.S. bought $28.0 billion less of foreign stocks and shifted from being a buyer of $57.8 billion of foreign bonds in 2011 to a net seller of $8.5 billion in 2012.  In spite of a substantial drop in foreign purchases of U.S. Treasury securities, The net outflow from all sources of direct and portfolio investment plunged by $118.6 billion between 2011 and 2012.

The U.S. economic recovery, now completing its fifteenth consecutive quarter has been disappointingly slow.  Real GDP rose by the thinnest of margins last quarter, a mere 0.1% annualized from 3Q12, and was just 1.6% greater than a year earlier.  But the composition of growth was not as poor as the overall figure.  Sequential economic growth in 4Q was depressed by a total 2.9 percentage points from a combination of slower inventory accumulation and declining government expenditures.  From the perspective of investors, these are desirable developments.  Moreover, the evidence of hard data and survey evidence for the first quarter of 2013 is heartening and has prompted analysts to on the whole ratchet their full-year growth forecasts upward.  The amazing ascent of U.S. stock prices have received a new boost from the mounting view that the drag from sequestration was overstated.

Compared to other developed economies, U.S. growth is strong.  Euroland’s recession will stretch beyond the middle of this year, and Japan is just emerging from recession with GDP still some percentage points below the pre-crisis level.  Japan and Switzerland are fighting deflation.  France had been a regional locomotive along with Germany but is now grouped with the region’s weak economies, leaving Germany isolated among the largest components of the group.  Voters have handed Italy’s government back to the clowns, and Britain is stagnating with GDP well below its pre-crisis high.

It’s fair to ask, shouldn’t the dollar be performing better.  In the the first 2-1/2 months of 2013, the euro, which is the best bilateral gauge of dollar sentiment, has slipped just 1.5% against the U.S. currency.  Several explanations come to mind.

  • Dollar inertia on the upside is consistent with the revival of risk appetite.  For much of the past six years, the dollar has moved inversely with risk-on trading.
  • Japan’s aggressive weak yen policy creates euro demand against Japan’s currency, which limits the euro’s weakness versus the dollar.
  • Currency movement in the short- to medium-run has more to do with market conditions (a currency might be overbought or oversold) than macroeconomic fundamentals.
  • The Fed’s quantitative easing is widely perceived as a weak dollar policy but without the rhetoric.
  • Secular reserve asset diversification is happening in the background.

Although America’s balance of payments appeared more supportive in 2012 than 2011, it became less so in the fourth quarter.  This may have reflected anxiety ahead of the election and fiscal cliff, in which case it should have faded as a phenomenon by now.  But perhaps, there has been some carry-over from the shift between the third and fourth quarters.  The table below breaks down the capital flow financing of the current account in each quarter of 2012 between private and official sources, and separates out the high-quality portion of private capital represented by direct and portfolio investment. Figures are expressed in billions of U.S. dollars.  Positive signs denote a net inflow.  Private includes the statistical discrepancy.  Sums may not quite add due to rounding error.

blns of $ 1Q12 2Q12 3Q12 4Q12
Current Acct -133.8 -118.4 -112.4 -110.4
% of GDP -3.5 -3.0 -2.8 -2.8
Official +119.6 +93.1 +145.5 +96.1
Private +14.2 +25.2 -33.0 +14.3
Direct & Port -41.4 -44.0 +48.4 +8.1


A second table below focuses on the eight components of direct investment and portfolio investment.  Changes in each component between 3Q12 and 4Q12 are noted in the right-most column, where a positively signed change indicates an increased net inflow, a reduced net outflow, or a swing from a net outflow to a net inflow.  The eight elements of long-term capital are U.S. direct investment abroad, foreign direct investment in the United States, U.S. buying of foreign bonds, U.S. purchases of foreign equities, foreign buying of Treasuries, foreign purchases of U.S. corporate bonds, foreign buying of U.S. agency bonds and foreign purchases of U.S. stocks. 

  3Q12 4Q12 Change
U.S. DI Abroad +90.9 +81.9 +9.0
Foreign DI in U.S. +41.8 +60.3 +18.5
U.S. + Foreign Bonds -0.0 +37.4 -37.4
U.S. + Foreign Stocks -2.1 +27.4 -29.5
Foreign + Treasuries +47.8 +26.0 -21.8
Fgn + U.S. Corporates -6.1 +7.5 +13.6
Fgn + U.S. Agencies +16.4 +18.5 +2.1
Fgn + U.S. Equities +37.3 +42.5 +5.2


This second table is related in the following manner to the first one: the sum of the quarter-to-quarter changes in the right-most column equals the $40.3 billion decline in net direct investment and portfolio investment from $48.4 billion in 3Q to $8.1 billion in the final quarter.  These figures can be found in the two right-most columns of the row labeled “direct and portfolio investment” in the first table.

Copyright 2013, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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