Lackluster Dollar All Things Considered

April 10, 2014

I confess that I’m a die-hard dollar bear, a predisposition that comes to me naturally.  In most manners of life, one’s early experiences are very impressionable.  I began studying economics in the mid-1960s when Keynes was king, so it was easy for me to be skeptical of contradictory theories such as monetarism.  My introduction to currency market watching — two stints totaling 15 months at the Federal Reserve of New York Foreign Department in 1975 and 1978 —  came in the early days of floating exchange rates and at a time of considerable dollar vulnerability.  In the first of those experiences, the Foreign Desk was still working painfully to pay back a tab of swap line debt run up defending the dollar in August 1971 just before gold/dollar convertibility had been severed and fixed U.S. exchange rates were abandoned.  1978 was a very difficult year for the U.S. currency, which was pounded relentlessly because of accelerating inflation and a deteriorating balance of payments and in spite of good U.S. economic growth. 

Flash forward to the present.  The dollar ought to be sailing along.  For the first time in years, the U.S. economy stands pretty much alone as the locomotive of the global economy.  Continental Europe is in a fragile recovery from two severe recessions since 2008.  Japanese growth slowed sharply in the second half of 2013 and now faces a blow of uncertain intensity from a national consumption tax hike.  Emerging markets have all sorts of problems, and even China continues to transition to a growth rate that is several percentage points below its norm.  Deflation poses a less pressing danger in the U.S. than to a wide spectrum of other economies.  The U.S. current account and public-sector deficits continue to narrow.  Whereas the Fed began to reduce the pace of quantitative stimulus in December, Japanese quantitative easing has not been trimmed, and the ECB has begun to consider introducing unconventional measures along such lines.  Geopolitical risks have intensified this year, giving investors ample reason to enhance their weights in “safe” U.S. asset holdings.  A long overdue correction of U.S. share prices appears to beckon.  A 10% correction would take the DOW back to 14,969.  A 20% bear market would land the index at 13,306, and a crash matching the Great Recession’s move would send the DOW all the way to 7,687.  When the index fell from 14,165 in October 2007 to 6,547 in March 2009, the dollar received considerable safe-haven support. 

Alas, compared to the announced start of quantitative tapering after the FOMC meeting last December 18, the dollar has lost 6.5% against gold, 2.3% against sterling, 2.1% versus the yen and 1.2% relative to the euro.  And going back to a base comparison of July 25, 2012 levels at the time ECB President Draghi promised whatever it might take to avoid a breakup of the European Monetary System, the dollar has fallen 12.5% against the euro and 7.8% against sterling.  To be sure, the dollar since that earlier time has risen about 30% against the yen and 21.5% vis-a-vis gold.

The yen, which gained considerable downward traction when massive quantitative easing was launched a year ago, has found depreciation harder to achieve recently.  April, which Japan’s fiscal year begins, is not a good month to resume a southward trend.  True, the yen fell 3.3% against the dollar during April 2013, but that was when the Bank of Japan’s quantitative stimulus began.  In the previous two dozen Aprils through 2012, Japan’s currency fell as much as 1.0% against the dollar just five times and not after 2008. 

There is a silver lining to having a depreciating dollar.  In a disinfrationary to deflationary global environment, faster import price rises are good medicine, and a weaker dollar buttresses the price competitiveness of American exports and import-competing goods.  Supporters in the Fed of the direction promoted by Bernanke and Yellen maintain that tapering doesn’t mean lessening stimulus, which they argue is linked to the outstanding stock of the central bank’s asset holdings rather than how such is changing.  For those analysts like myself that remain unconvinced by this argument, it still seems that U.S. monetary conditions have become looser since mid-December.  The dollar has fallen, and so have long-term interest rates.  Compared to January 3rd of this year, the 30- and 10-year U.S. sovereign debt yields have fallen by 35 bps and 30 bps. 

Medium-term currency forecasting is very hard to do correctly.  Early on, I concluded that the burden of proof in a debate lay with dollar bulls over whether the U.S. currency would likely be rising or falling against major rivals.  In the 41 years of floating exchange rates, there have been just two examples of sustained multi-year dollar uptrends.  Such didn’t prevent the U.S. economy from being a growth leader, the restoration of a desirable inflation rate, buoyant corporate profits, good market performances in U.S. bonds and stocks.  Even more important, the dollar’s position as the worlds preeminent reserve asset currency and all the advantages that such bestows has not been jeopardized. 

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



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