Dollar Strength Depends on One’s Frame of Reference

February 25, 2015

The dollar has already gained considerable ground against a broad cross-section of other currencies, propelled by relatively strong U.S. growth and the divergent direction of monetary policy guidance from the Fed and the policy outlook for many other central banks that have recently loosened their credit stances and are signaling a bias favoring more support.  Since only end-2014, monetary policy rates have fallen in Sweden, Switzerland, Canada, Australia, and Denmark, The greenback has appreciated 23.3% compared to its lowest level against the euro in 2014.  On similar comparisons, the U.S. currency has risen 20.4% versus the Aussie dollar, 18.0% against the yen, 17.4% relative to the Canadian dollar, 16.9% against the kiwi, about 14% on a trade-weighted basis against other freely floating monies, 10.9% vis-a-vis sterling, 9.1% versus the Swiss franc and 5.4% against gold. 

The dollar has risen, too, against many emerging market currencies.  Just this past week, authorities in Azerbaijan devalued the manat by 34% against the U.S. currency.  The dollar is some 4% firmer against the Chinese renminbi than its 2014 low and expected by many to perform even more strongly against that currency in 2015 than 2014. A month ago, the Monetary Authority of Singapore at an unscheduled review flattened the slope of the S-dollar’s trading band, and central bank interest rate cuts have occurred this year in Indonesia, Israel, Turkey, Egypt, India, Botswana, Uzbekistan, Romania, Albania, Russia, Pakistan, Jordan, Argentina and Peru.

From an entirely different point of view, the 30th anniversary tomorrow (February 26, 2015) of the dollar’s strongest level in the floating exchange rate era against most European currencies, the dollar does not look so robust.  Along with 1973, 1985 was one of the strangest currency market years that I can recall.  Prior to February 26, the U.S. currency advanced 10.2% against the mark, even more than its 6.6% year-to-date appreciation against the euro.  But after peaking that day, the U.S. currency plunged 29.5% over the rest of 1985 relative to the mark and also lost marginally more than 20% vis-a-vis the Japanese yen against which it had risen 4.3% earlier in 1985.  In relation to its levels 30 years ago, the dollar now shows massive losses of 67.6% against the Swiss franc, 54.6% relative to the yen, and 50.4%, 23.6% and 21.7% against the euro translation values of the German mark, Spanish peseta and Italian lira. The U.S. dollar is now 41.8%, 11.6% and 11.5% weaker than then against the New Zealand, Canadian and Australian dollars.  One of its biggest plunges has been a 76.4% drop against gold, and it has managed to rise just 5% against the euro translation value of the Greek drachma. 

How one views the dollar depends on one’s frame of historical reference to which one compares current levels.  The aforementioned peak dollar levels of late February 1985, for instance, may have been among the priciest dollar values of the post-March 1973 period of flexible exchange rates, but even those were well below parities from the previous fixed exchange rate era.  The dollar was devalued in December 1971 and again in February 1973 as the international monetary system transitioned from one era to the next.  In the wake of World War II, which rampaged economies in Asia, Europe, Africa but not North America, the old fixed exchange rates were initially quite appropriate.  Comparatively high U.S. inflation and yawning current account imbalances eventually imposed unmanageable strains on what had been known as the Bretton Woods regime, which gave way to a different system that allowed market forces to set currency values that would clear market supply and demand more efficiently. 

The dollar now lies between vastly wide borders defined by what worked in the 1950s and the U.S. currency’s flexible era lows.  There is even a huge amount of room for the dollar to climb before approaching the flexible era highs reached thirty years ago.  Moving upward from current levels, the dollar is on a journey through waters not traveled in a very long time.  The fundamental economic underpinning for its rise so far aren’t fading soon: unsynchronized monetary policies, low but non-negative U.S. inflation, and a U.S. current account imbalance that’s comfortably below 3% of GDP and not trending upward yet.  All other things being the same, dollar equilibrium over the short run (the first half of 2015, if not the second half too) ought to be a direction (upward) rather than any point.  But all other considerations will not remain static — they seldom do — and three big potential disturbances on the radar screen are

  • Geopolitical shocks and national political upheavals.
  • Government efforts to override the will of market forces through verbal comments and more concrete policy actions.
  • The uncertain response of other financial markets when increases in the federal funds rate finally begin.

So there it is.  The dollar has been rising, a direction that makes sense based on fundamental economic comparisons that are not going to shift soon.  The dollar should recover more ground against a wide spectrum of other monies, and the dollar is not bumping up against extremes that would melt away the dollar’s advantages.  However, there exist other considerations that could upend this upbeat outlook much sooner than the grinding evolution of economic fundamentals would normally suggest.  Stay tuned.

Copyright 2015, Larry Greenberg.  All rights reserved.  No secondary distribution without express permission.



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