Long-Term Dollar Prospects

July 22, 2008

The basis for U.S. Treasury Secretary Paulson’s faith in a stronger dollar over the long run rests on the assertion that no other developed economy has better long-term fundamentals than America.  There’s that poorly defined word again, fundamentals, which officials and private analysts throw around too much.  Fundamentals, like beauty, are in the eyes of the beholder.  It could mean relative economic growth, relative per capita growth, expected returns on real and financial investments, trade competitiveness in merchandise and services, political stability, central banking skill in anchoring actual and expected inflation, or hardware infrastructure (e.g. transportation) and software infrastructure (e.g., education to develop high-quality human capital).  It could even involve something as simple as the commitment of the political leadership to change policy in response to chronic movement in the exchange rate.  “Long run” is another elusive term that economists use.  Does Paulson mean a year, two years, a business cycle, or ten years?  How about 50 years?  Surely a half century qualifies as a long piece of time.

Over the past fifty years, U.S. real GDP rose 3.4% per annum, and employment advanced at an annualized rate of 2.0%.  Those rates represent a pretty good performance, and comparisons of demographics and U.S. productivity over the last decade suggest positive long-term results ought to persist.  On the other hand, adverse comparative studies of student performance across different countries cast doubts on whether past really is prologue in this instance.  U.S. inflation has been more problematic than growth, with the CPI recording per annum increases over the past fifty years that average out to an unsatisfactory 4.1%.  Long-term trends in public finances look bad for the United States, but it is worse for some other economies.  Chronic current account deficits, like the one the U.S. habitually runs, have a tendency to provide their own energy, so that negative factor is probably not going to fade away.  A permanent state of war will crowd out the ability to maintain infrastructure properly.  On balance, one is left to conclude that any edge enjoyed by the United States in match-ups of economic fundamentals over the next 50 years is just as likely to be no better as to be no worse than such was in the last 50 years.

So how did the dollar do while GDP, jobs, and CPI inflation were advancing at annual rates of 3.4%, 2.0% and 4.1%?  Against values in 1958, the dollar is down by 70.2% against the yen, 76.4% against the Swiss franc, and 69.0% against the synthetic Deutschemark.  It even has lost 15.8% against the synthetic French franc.  The dollar rose against sterling by 20.5%, a sign of what happens to a former dominant reserve currency after it loses that role in the international monetary system, and the greenback advanced 96.3% relative to the hapless synthetic Italian lira.  Some of dollar’s erosion over the last 50 years should not be considered a falling dollar so much as a sign of strength in certain currencies of Europe and Japan, which was to be expected since their rebound from the devastation of the second world war generated miraculous results.  However, the return from war devastation lost its validity at least 25 years ago as an explanation for dollar deprecation. 



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