Dollar Uptrend Substantial Already

November 12, 2014

Despite deepening concern about the euro area’s economic outlook, the dollar’s recovery versus the euro understates the U.S. currency’s overall turnaround.  EUR/USD had declined slightly less than 10% since the start of 2014 but only 5.5% since the end of 2012.  Almost 7/8ths of a 33% plunge in the Russian ruble since end-2012 happened this year.  Some currencies that have lost at least a fifth of their dollar value since end-2012 are the Japanese yen, the South African rand, the Indonesian rupiah, and the Turkish lira.  Monies that have depreciated 10-19% against the dollar over this span include the Brazilian rand, Australian dollar, Swedish krona, Indian rupee and Canadian dollar.  The Thai baht and New Zealand kiwi are down 6.7% and 5.1%.  Sterling slipped 1.9%, and the Chinese yuan, although showing a small decline thus far in 2014, is 1.7% above its end-2012 quote.

The trade-weighted dollar (TWI) was last as strong as now in April 2009, just about three months before the end of the U.S. recession.  The TWI has risen 12.7% since end-2012 and 21% trade-weighted appreciation since early May of 2011.  America’s greatly reduced dependency on imported energy has neutralized the impact of the dollar’s rebound on the U.S. trade deficit, enabling the United States to maintain its clear growth advantage vis-a-vis other advanced economies.  More about that a little later, and to cast more perspective on the trade-weighted dollar recovery, recouped ground represents less than a third of the plunge between mid-2001 and May 2011.  Indeed, the trade-weighted dollar is still 31.4% weaker than its peak on July 6, 2001.

The currencies of other advanced currencies have not performed as well as the dollar in trade-weighted terms since the end of 2012.  The yen on such a basis has slumped about 23%.  The Canadian dollar has fallen 10%.  The trade-weighted euro is down 4.7% this year so far, but that slide only reverses the common European currency’s rise in 2013.  To support demand and boost Ezone import prices, a much more extensive depreciation of the euro than seen in 2014 is vitally required.  In trade-weighted terms, sterling has settled back marginally since mid-year after advancing 4% in the first half of 2014 and remains 5.2% above its end-2012 value.

A prime reason for the dollar’s resurgence has been America’s chronically stronger economic growth, which is expected to persist.  The table below compares U.S. growth to the pace in Euroland, Japan, and Britain.  For 2014 and 2015, assumed growth matches the mean forecasts for those years revealed in The Economist’s November survey of forecasters.  Figures for 2011-14 represent average per annum growth in that four-year period.  Note that the U.S. economy is projected to enjoy a bigger advantage in 2015 than 2014 against the euro area and Japan.

GDP Growth 2011-14 2014 2015
U.S. 2.1% 2.2% 2.9%
Euro Area 0.3% 0.8% 1.2%
Japan 0.9% 0.9% 1.1%
Britain 1.5% 3.0% 2.7%

Relatively strong growth in the United States would not be a sufficient factor to extend the dollar’s upward trend.  History shows time and again that this condition is not necessarily incompatible with a depreciating currency.  In those earlier instances but not now, however, the strength of U.S. aggregate demand was associated with accelerating and undesirably high U.S. inflation and/or a deteriorating current account.  The verdict on whether or not U.S. inflation accelerates from here is out.  That’s the conventional wisdom, but it’s been so for many years now and proven mostly wrong.  And even if inflation does rise closer to the 2% target, U.S. inflation will be at a healthier and more appropriate level than in Europe or Japan.  Regarding the current account deficit, its size relative to GDP peaked just before the onset of the financial crisis.  The largest calendar year shortfall was a deficit-to-GDP ratio of 5.6% in 2006, and deficit was at 5.0% or higher for four straight years through 2007.  That’s more than twice last year’s 2.4%, and the ratio did not increase in the first half of the current year.  Nor is it expected to widen in 2015.

Listening to the victorious Republicans in this month’s U.S. election, one would conclude that the American economy is an utter mess, but investors believe differently as attested by near record-high equities, a rising dollar, and a Treasury market that defies pundit predictions of a debacle.  Unlike China, U.S. growth is not four percentage points below the not-so-distant norm.  The U.S. economy is making huge strides toward energy independence, while Japan gets punished for abandoning nuclear power and Europe stays hostile to the whims of Vladimir Putin.  It’s highly debatable that Euroland will avoid regional deflation or that Japan will achieve deflationary escape velocity.  Japan’s current account surplus is but a shadow of its former self, and the Abe government faces a Hobson’s choice on whether to hike the sales tax to 10% next October.  If officials proceed with the tax, ample personal consumption will not ensue, and if the tax is delayed, fiscal credibility will be damaged.  The U.S. federal deficit, in contrast, has moved under 3.0% sooner than imagined.  America’s problems are comparatively amorphic like a broken political system, floundering wage and income growth for most people, and neglected infrastructure.  But all things considered, the stars seem to be still aligned in the dollar’s favor.

Copyright 2014, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.

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