Dollar Reflecting an Erosion of Respect
January 24, 2018
Viewed from a very wide angle lens, currency valuations reflect the present value of a country’s perceived future. The perceived economic potential of a nation plays a big role in this evaluation. Investors want a store of value that is associated with a steady and desirable rate of inflation. A currency that holds its internal value over time tends to perform well externally as well. Investors are also attracted to currencies of economies with other favorable properties, like manageable fiscal and external imbalances and appropriate long-term expansion rates of jobs and real GDP.
In the rarefied set of reserve asset monies and currencies aspiring for such a status, non-economic matter can be as, if not more, influential in determining whether a currency strengthens or weakens. In the early 1980s, U.S. monetary policy was tightening, fiscal policy was loosening, and the Reagan administration pushed deregulation to promote growth — all things that are being done again. Back then, the dollar roughly doubled in value against the mark and yen during the four years to early 1985. This time, the dollar fell in 2017, and the descent has recently accelerated. Over the past four months, the dollar has dropped 4-5% against the euro, yen and on a trade-weighted basis. What gives?
The strength of the dollar in Reagan’s first term also stemmed from a reduction of inflation and that administration’s leadership in rallying America’s western allies to face down Russian communism. U.S. self-respect and the respect for it felt in other countries had been squandered by the Vietnam War, Watergate and the Iranian hostage crisis. A malaise in the United States gave way to can-do optimism in foreign policy, social tranquility, and in paving the path for new technologies.
Reagan would be very comfortable with “Make America Great Again” but probably would prefer “Make America Respected Again.” That’s not possible with an America first approach that behaves like a bully, pits citizen against citizen, shelters unproductive old industries, obstructs the development of new ones, cuts immigration to a trickle, and dismisses the importance of a good education for its homegrown people.
The dollar’s external value is a more accurate assessment of the U.S. market brand that are equity prices or a quarter or two of GDP growth. Stock prices depend on expected corporate earnings, which will be goosed by the U.S. tax cut and are already benefiting from the strongest global growth since 2010. The S&P’s 10.8% rise over the past three months is only marginally better than the Japanese Nikkei’s 9.8% advance.
Dollar depreciation, juxtaposed against a rising yen and euro and the increase of U.S. tariffs on selected imports, moreover may not only herald rising inflation but almost surely means that U.S. inflation will climb faster than inflation elsewhere. It is not surprising, therefore, that the 10-year Treasury yield has risen about twice as many basis points as have the comparable German bund yield during the past three months. Nor, for that matter, should one infer that a widening long-term yield differential under these circumstances will or should lend the dollar much support.
The wealth effect of stock market appreciation benefits a comparatively small slice of the population and thus should not be touted as compelling vindication that the U.S. tax bill is on balance just what the economy needs. Purchasing manager surveys for January released today, on the contrary, suggest that the rate of growth is accelerating in Japan and Europe but slowing in the United States. IHS Economics reported preliminary PMI results for all three economies.
- The U.S. composite PMI in January of 53.8 was 1.4 points lower than that three months earlier in October. While factory activity rose 1.7 points to 55.5, the more comprehensive services PMI fell to 53.8.
- Euroland’s composite PMI climbed 2.6 points to an 11-1/2 year high of 58.5 in January from 56.0 in October. The services PMI climbed 2.6 points as well, while the manufacturing PMI of the euro area went up by 1.1 points.
- Japan’s manufacturing PMI of 54.4 in January was 1.6 points above its level three months before.
Newfound U.S. isolationism seems incompatible with long-term dollar hegemony in reserve asset portfolios. At this stage, it’s highly uncertain whether the new ideas being implemented by the Trump administration will mark an irreversible C-turn in the country’s 240-year history. At the moment, no obvious alternative reserve asset has the full range of necessary elements to challenge the dollar, so a stampede out of the U.S. currency is not likely. But the fact that the slip-sliding trend of 2017 has extended into January isn’t very surprising, even in the face of a usual seasonal bias for the dollar to climb in the first two weeks each calendar year.
Copyright 2018, Larry Greenberg. All rights reserved. No secondary distribution without express permission.
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