Some Factors to Consider When Handicapping Dollar’s Outlook

February 21, 2017

Fake News that is likely to become even more prevalent will present many challenges to currency forecasters. Even if the U.S. press and the intelligence community try to stand their ground, the executive branch of government enjoys great advantages in creating doubt and confusion in the public’s mind over what to believe. The two watchdogs are being kept out of the loop. Investigative reporting will pull punches for fear of libel lawsuits. Less federal money may be allocated to fund data collection and law enforcement. The Congress can be expected to be far less adversarial in dealings with the current president than it was with Obama. A cloud may hang over the accuracy of reported U.S. economic data, and if that reliability becomes suspect, the whole notion of market prices moving in a way consistent with economic fundamentals would lose its meaning. The infiltration of fake news into public understanding of what’s really happening introduces a whole new layer of uncertainty into how markets react to events, data, and alleged truths.

There is a critically important missing element from comparisons to the early 1980s when the dollar appreciated against a backdrop of tight monetary policy and loose fiscal policy. U.S. consumer price inflation plunged from 14.8% in March 1980 to 2.5% by July 1983 and a cyclical low of 1.1% in December 1986. The speedy restoration of price stability from a point when the markets wondered if low inflation would ever be experienced again was arguably the most influential factor behind a doubling of the dollar’s value against the mark and yen. A decade later when the federal funds rate doubled to 6.0% during the year to January 1995, the dollar was not similarly well bid. Similarly, the dollar did not perform well during George W. Bush’s presidency despite a very expansionary fiscal policy and a rise in the federal funds rate from 1.0% in June 2004 to 5.25% two years later. Inflation did not fall in 1994-5, and it climbed a percentage point between mid-2004 and mid-2006. U.S. inflation is widely expected to be higher, not lower, in 2017-8 than in recent years. That sets the current period apart.

Does the U.S. President Want a Rising or Falling Dollar? Eliminating a chronic U.S. trade deficit has been identified as a major priority of the new administration. Import tariffs and border taxes are threatened to promote that goal. A depreciating dollar would support the objective as well, and President Trump has already broken the tradition of presidents not commenting about the dollar by complaining, for example, about a perceived undervalued euro. The Treasury doesn’t have to undertake intervention — purchases in the market of euros, yen and other currencies against the dollar — to heavily influence foreign exchange trading, although such an option is available as a last resort. The avoidance by presidents of remarks about foreign exchange rates doesn’t prevent other government spokesmen from doing so. At times when that has happened in the past, I cannot recall an instance when a weaker dollar failed to ensue.

Mass deportations from the United States do not seem compatible with the dollar remaining the world’s reserve currency hegemon. Nor does a close geopolitical alliance between the United States and Russia. Until now, the dollar’s role as a reserve currency with no close equal has gone unchallenged, and it takes considerable time for reserve asset preferences to become reordered. On economic grounds, the United States continues to be the one-eyed man in the land of the blind. While U.S. growth this century has been far weaker than in the last one, Euroland and Japan are performing even worse. Europe, moreover, faces the same ascendance of nationalism as seen in the United States and significant political watersheds from this year’s French, Dutch, and German elections. A near-term Greek debt crisis has been avoided, but Italy’s situation could regress.

Finally, old rules of thumb like the exceedingly slow changes in reserve asset portfolio management cannot be readily assumed. Whether one embraces or worries about coming changes in U.S. economic, social and foreign policies, a consensus on both sides exists that this is an activist government with an agenda to change things profoundly and a will to do so as quickly as possible by legal or whatever other means it can find.

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




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