Tuesday, December 22, 2009

Gravity will drag the $US

The US dollar ($US) is on a roller coaster. And since S&P downgraded Greece to BBB+, the dollar has been on the rise. One can attribute the recent shift in the $US to many things - improving US economic conditions, return to risk, or relative weakness in other G7 countries, whatever. But what is clear, is that the dollar's gaining some strength, 4.7% since the beginning of December on a trade-weighted basis.

But this is not sustainable. As economic recoveries diverge (i.e., the G7 recovery is expected to be slower than that in key emerging markets), the dollar will likely fall. That's just gravity, and a necessary condition for sorting out global trade flows.

The chart illustrates the effective value of the $US, which is a composite index of the value of the $US against US trading partners (one source for this data is the Bank of England). As recently as November, the $US slid to its lowest value since March 2008. At that time - and really anytime the $US initiates a descent - Washington gets all worked up; but why? One of the necessary conditions for the re-balancing of trade flows between major trading partners is dollar depreciation.

Just look at the contribution to GDP growth from exports in 2006 and 2007, when not coincidentally the dollar was sliding.

The chart illustrates export growth and the contribution to GDP growth, as released by the Bureau of Economic Analysis. Note: an easy way to get this data is to simply download the excel file in the right sidebar of the release page.

A weak dollar can drive economic growth - especially as trade resumes, and emerging markets see a much quicker rebound than that expected for the G7. According to the Financial Times, its already happening - Asia ex-Japan is moving Japan's export market:
Japanese exports continued to increase in November because of robust demand from Asia, easing concerns about the strength of the country’s economic recovery.

Real exports were up by 0.6 per cent on October, according to Bank of Japan data. This was the eighth consecutive monthly rise, although the pace of increase was the slowest since exports began to recover in April.
A weaker dollar is a big part of the story for a re-balancing of trade flows. And its not just a US and China problem. According to the IMF, the 2007 US current account deficit was $731 billion, while the value of China's surplus was just half that, $372 billion. It's much of Asia and the Middle East that are likewise driving imbalances (of course, the US is not an innocent bystander here). The dollar will see weakness again on a trade-weighted basis; that's gravity.

Rebecca Wilder


  1. A weak currency is not a cause; rather it is a symptom of a weak, noncompetitive economy. In time, a declining dollar will eliminate the deficit in our balance-of-trade. But the price exacted will be a sharp decline in imports, principally oil, and the purchase of foreign services, reflecting our relative poverty and inability to compete in the international economy.

    The problem is that further depreciation of the dollar will not correct our foreign trade deficit. In fact, further depreciation will only make our stocks and real estate even cheaper and even more attractive as a safe haven in this dangerous world.

    The “foreign trade deficit” & the “domestic federal deficit” have an insidious, if not an incestuous, relationship. An increase in the demand for loan-funds is reflected in higher interest rates than there would otherwise be. Higher interest rates are significantly responsible for an “over-valued” dollar which is in turn the principal contributor to our burgeoning trade deficits.

    The volume of dollar-denominated liquid assets held by foreigners is extremely large. Any significant repatriation of these funds, by reducing the supply of loan-funds, will force interest rates up – thus increasing the federal deficit and the burden of all new debt. These events alone could trigger a downswing in the economy resulting in more unemployment, more unemployment compensations, less tax revenues and larger federal deficits.....the US must produce higher quality and lower cost, goods and services....even these changes won't be sufficient.

  2. The dollar ceased to be convertible into gold for one reason only (our overseas military expenditures). I.e., the past U.S. military's far flung bases
    (700), & 400,000 military personnel, and wars caused the chronic trade deficits which were responsible for gold being severed from the dollar in March 1968 (at the height of the Viet Nam war). The major contributions includes the Korean War, Viet Nam War, Communist containment policy, & foreign bases).

    These deficits laid the basis for the prudential Euro-dollar market and its excessive contribution to World wide inflation.

    These deficits existed despite the fact that the private sector ran surpluses in all their accounts except 1957.

    Today, there are 820 installations in at least 39 countries (widipedia). Since 9/11, military expenditures abroad totaled $944 billion. The Iraq was cost $683 billion alone.

    The point is that the exchange value of the dollar will continue to decline just based on our military expenditures overseas. And this excludes our oil dependence deficit.

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  4. @ $77 dollars per barrel & 7.2 billion barrels per annum, our energy dependence costs the U.S. $554,400,000,000 billion per annum.

    Add our growing energy dependence & the military industrial complex together and we have an insurmountable trade deficit.

    I.e., the U.S. will quickly reach a point to where it won't be able to fight wars abroad.

  5. "The Association for the Study of Peak Oil and Gas (ASPO) predicted in their January 2008 newsletter that the peak in all oil (including non-conventional sources), would occur in 2010"