Dollar Not Reacting Excessively to U.S. Political Instability

May 15, 2017

Not in decades has “Watergate” been so often cited in the news as a base of comparison for judging current events. Forty-five years separate the Trump Presidency from the criminal break-in to Democratic Party headquarters on June 17, 1972. This wide expanse of time is as great as Watergate was from the roaring 20s and the presidency of Calvin Coolidge and perhaps can best be compared to the equally vast difference between how markets responded very sensitively to the Watergate scandal and how impervious markets are lately to the parade of political surprises.

U.S. share prices and the dollar tumbled as the Watergate scandal unfolded. From a peak of 1052 on January 11, 1973 shortly before one of the burglars revealed the involvement of others to a low of 577 nearly two years later on December 6, 1974, the Dow Jones Industrial Average slumped 45%.

The Watergate break-in occurred late in the post-WW2 Bretton Woods era of fixed dollar exchange rates but between an initial devaluation in December 1971 and a second devaluation in February 1973. That second change in dollar parity rates failed to alleviate market strains and was quickly followed a month later by the abandonment of fixed rates. When former President Nixon chose to resign in August 1974 rather than an impeachment trial that assuredly would have removed him, the dollar was 16% weaker against the German mark than it had been at the time of the break-in, but the yen was up less than 2% over the same period.

The U.S. economy was pretty sound at the start of the Watergate crisis but deteriorated progressively as it unfolded. Real GDP posted back-to-back calendar year gains of 5.3% in 1972 and 5.6% in 1973. But following the Yom Kippur Middle Eastern war in October 1973, a rapid quadrupling of world oil prices lifted U.S. CPI inflation above 10.0% and plunged the economy into a prolonged recession. The distraction of Watergate hampered the effectiveness and will of economic policymakers to counteract the problem. Real GDP on average fell 0.5% in 1974 and another 0.2% in 1975. Inflation moved lower for cyclical reasons but would climb even higher later that decade when economic expansion resumed.

Now fast forward to 2017. Allegations of obstruction of justice can again be heard in the land, but stocks and the dollar thus far have been resilient. Today completes the third eighth of the year. From end-2016 to February, the DOW rose 4.3% on balance to 20,612. In the second half of 1Q17, the market edged up 0.2% to 20,663, and it’s currently another 1.5% higher at 20,981. Unlike the Watergate years, the dollar fell during the first quarter of 2017 more sharply against the yen (4.7%) than the predominant European currency (1.3% versus the euro). However, the most recent month and half has again seen greater movement in the dollar occur at the expense of Europe than Japan, such that it is down 4.1% year-to-date against the euro versus a loss of 2.8% relative to the yen.

U.S.¬†economic activity is growing much more weakly now than when the Watergate crisis began. Real GDP grew 1.6% on average in 2016, down from 2.6% in 2015. Quarter-on-quarter growth expressed at an annual rate slowed from 3.5% last summer to 2.1% in the final quarter of 2016 and 0.7% in the first period of 2017. Moreover, last quarter’s pace was less than half as much as the euro area’s 1.8% rate and probably only about half as much as Japan’s growth, too.

These are very early days in the Trump presidency. However, it would be shocking if confrontational politics full of surprises and controversy didn’t continue to flow out of Washington. With U.S. long-term interest rates remaining very low, dollar depreciation for now suits the president’s economic objectives better than the alternative at least — it seems safe to say — so long as the rate of depreciation remains moderate, and currency markets remain orderly and not straight-lined in direction.

Copyright 2017, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

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