U.S. Economic Fundamentals and the Dollar

February 11, 2021

The dollar is currently much closer to its 52-week lows than its highs over that period against the euro, yen, Swiss franc, Chinese yuan and on a trade-weighted basis. Depreciation has been very orderly overall. The decline has transpired in fits and starts, and cumulative losses are moderate compared to many historical periods of slide. But for the most part, depreciation is consistent with U.S. economic conditions, and the dollar is far from unchartered waters. On these criteria, no strong reason exists not to expect more slippage.

Narrower Long-Term Interest Rate Differentials: The premiums of ten-year U.S. Treasury yields over German and Japanese rates are smaller than they were a year ago.

Chronic Current Account Deficit Has Widened: Some the dollar’s notable cycles of weakness during the floating exchange rate era were associated with U.S. current account deficits that exceeded 3.0% of GDP and, in one case, approached 6% of GDP. For much of the time since the Great Recession, the deficit was much more manageable in size, averaging 2.4% of GDP in 2012-2018, then slipping to 2.3% in 2019 and 2.1% in the first quarter of 2020. In the second and third quarters last year, however, the shortfall ballooned to 3.3% and then 3.4% of GDP.

Declining Growth Potential: Per annum GDP growth averaged 3.1% in the 1950s, 4.3% in the 1960s, 3.3% in the 1970s, 3.2% in the 1980s, and 3.6% during the decade that ended in the final quarter of 2000. That robust pace slowed to 1.7% in the 20-nought decade and 2.4% in the ten years through the end of 2020 despite the absence of any recession in that period. In contrast to 3.0%-plus average growth in the last five decades of the twentieth century, growth of 3.1% or moreĀ  happened subsequently only in 2004 and 2005 in the years between 2001 and 2019, and sub-zero growth was experienced of -0.3% in 2008, -2.8% in 2009, and -3.5% in 2020. Until and unless growth above 3.0% is sustained, it’s fair to conclude that after so long missing that mark that the rate of potential GDP has slackened too, even though measuring that concept is difficult.

A More Astonishing Jobs Deficit than Fiscal Deficit: U.S. employment growth was extremely stable in the last fifth of the the 20th century, averaging 1.83% per year in the both the ten years through December 1989 and in the ensuing decade. If that well-established trendline had continued past Y2K, America would now have 191.4 million non-farm payroll jobs, but the total as of last month stood at 142.6 million workers. That level remained 9.8 million less than the pre-pandemic crest of 152.4 million and was associated with a 6.3% unemployment rate, which coincidentally was the peak reading associated with the dot-com recession.

Inflation that Has Been Too Low for Too Long: Since former Fed Chairman Volcker’s successful war to lower inflation, above-target inflation readings have been a positive dollar factor because such implied tighter monetary policy. But for way too long in recent years, inflation in the United States has undershot the 2.0% target — so much so that the Federal Reserve redefined its inflation target objective from a level at any time to an average level over an extended period of time. That means officials will not be satisfied if inflation merely returns to 2.0%. It must exceed that level somewhat and sustain that overshoot for sufficient time to offset the long episodes of under-2% inflation. U.S. inflation has begun to rise lately, but so has inflation in many other economies. Moreover, uncertainty in the tweak of the Fed price stability paradigm means that upwardly trending inflation probably will not lend the dollar support this time.

What Nation Will be Supreme This Century?: The last century was clearly America’s century, and it made complete sense coming out of World War 2 to create an international monetary system anchored around the dollar. Whether America repeats as global hegemon in the 21st century is in doubt. It’s not a good omen that the United States accounted for 1.35% of global deaths from the Spanish flu some hundred years ago but is associated with a fifth of the deaths from Covid. Infrastructure is in greater need of repair in the United States than in many other economies. Global trust in the United States government took a huge blow from its propensity to weaponize economic policy, all too often resorting to protectionist tariffs and a wide range of other sanctions against nations with whom the U.S. has a foreign policy beef.

Is America the Same Can-Do Nation that Climbed Out of the Depression and Defeated Fascism?: Whatever the result of the impeachment senate trial, taking Trump out of the White House hasn’t removed Trumpism from the Republican Party. There are huge problems that cannot be solved by private enterprise and on a state-by-state basis. If one half of the U.S. body politic remains dedicated to deconstructing government by whatever means it finds effective, the nation is still in big trouble. And since the obstructionist half doesn’t really reflect either half of the adult population or half of its GDP, it will be very hard for America to get past the toxic intra-U.S. political bickering. This is a very old problem. As thirteen previous colonies, the initial experiment with the Articles of Confederation that put states foremost and above the people and any national identity flopped terribly. Disagreements over states rights were central to the lead-up to the Civil War and to the deconstruction of reconstruction. The great moments in America’s story-line have been times when the nation got past the parochial and tackled a problem with national purpose.

A Good Start for Biden: The president has surrounded himself with a highly qualified team of advisers. Meritocracy again counts for something, and Biden hasn’t repeated the early mistakes of the Obama administration tempering needed fiscal stimulus in order to appease political opposition. That still might not be enough if the Republicans continue to lean to the extreme right and remain blatant deniers of truth. The GOP pendulum will swing back only so far as its base will allow, and the unchecked influence of cable and social media greatly complicates that matter.

Dollar Policy: Currency movements are influenced by investor perceptions regarding what political leaders will tolerate, and there are always boundaries since excessive currency movements can undermine basic economic objectives. U.S. officials have had little to say about the dollar in a long time. From current levels, its seems doubtful that a further orderly erosion of the dollar would be unwelcome. It’s a different matter for the leaders in Europe and Japan. That’s from where a protest against more dollar softness is likeliest to come. It’s also possible that if the pandemic’s drag on U.S. economic activity lessens sooner and faster than baseline expectations that the dollar will be lifted anyway, and in that context, dollar appreciation would not be a concern to the Biden Administration.

Copyright 2021, Larry Greenberg. All rights reserved. No secondary distribution without express permission.




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