Dollar faces long journey downward

October 13, 2009

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- James Saft is a Reuters columnist. The views expressed are his own –

Even putting aside the spectacular but hard-to-measure risks of a financing crisis or the loss of its special status, the dollar faces really serious headwinds from boring old fundamentals.

The dollar has been weak for months and markets have been fretting over a host of big picture worries.

Perhaps the world’s oil exporters will stop using the dollar as the medium for petroleum trade. Or maybe the so-far patient and docile buyers of Treasuries will finally turn jittery. Either could be a disaster for the dollar, but you don’t need conspiracies or crises to be bearish on a currency from a country which on some measures has run the largest-ever deficit between what it imports and what it sells abroad.

One of the most interesting side effects of the first part of the financial crisis was that the dollar actually rose despite being the locus of the credit bubble and despite the U.S. consistently importing far more than it exports. That strength, which has now been reversed in part, was largely because the freezing up of markets set off a scramble for dollars.

The acute phase of the crisis is over and a return to something approaching normalcy is not treating the dollar kindly; from its peak this year the dollar has fallen more than 13 percent against a trade-weighted basket of currencies. The current account deficit — the balance of exports to imports — has also been reduced greatly, from a peak north of 6 percent of GDP to below 3 percent at the end of June, with further narrowing in the months since. That is because a weaker dollar makes U.S. products more competitive, but also because the price of oil, of which the U.S. is a net importer, has dropped, and consumption at home is flagging.

It is far too early, however, to say that the dollar adjustment has done its work and the deficit will now close.

“The U.S. current account shortfall was primarily driven by a consumption surge rather than an acceleration of investment on the back of productivity growth and high profitability,” Citigroup currency strategist Michael Hart wrote in a note to clients.
THINGS THAT CAN’T GO ON FOREVER DON’T

That is bad news for the dollar and bad news for the outlook for U.S. growth. A 2005 paper by Caroline Freund of the World Bank and Frank Warnock at the University of Virginia <http://papers.ssrn.com/sol3/papers.cfm?abstract_id=875699> found worse outcomes for the countries that ran current account deficits to finance consumption as opposed to those which ran deficits in aid of investment.

Industrialized countries which, like the U.S., run current account deficits for consumption, find that the currency depreciation that follows tends to be deeper. What’s more, the adjustment in the deficit lasts longer and is often twinned with lower growth. It is not, I suppose, a big surprise that importing more than you export and then consuming it leads to depressed growth. The real wonder is the way in which the U.S.’s special status and the generous financing terms offered by its trade partners made this possible without more immediate damage to the dollar.

There is also the possibility that globalization has permanently raised the “natural” level of the U.S. current account deficit. Huge swaths of the U.S. manufacturing base and a growing wedge of the country’s service sector have been offshored or simply moved out of the U.S. Many of these goods and services are still consumed by the U.S., but now much of the money generated by those sales will be the result of dollars being sold to buy pesos, ringgits or yuan.

This may place more structural pressure on the dollar to fall over time.

Australia’s decision to raise interest rates last week hurt the dollar and for good reason. It demonstrated that as a recovery happens the action will not be in the U.S., but in resource-based economies and in places, mostly in Asia, where the best prospects for productive investment lie. The U.S., where the Federal Reserve will likely need to keep rates low for a very long time, will have a hard time capturing the imagination of investors.

For policymakers, and not just U.S. ones, the puzzle is how to allow the dollar to fall gently without precipitating trade friction or a disastrous loss of confidence. Because it’s more or less in everyone’s interest, it will probably more or less be avoided. A weaker dollar, though, is simply consistent with the outlook for the U.S.

A long shamble downwards rather than a fall off a cliff looks to be in the dollar’s future.

(At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. )

68 comments

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“The U.S., where the Federal Reserve will likely need to keep rates low for a very long time, will have a hard time capturing the imagination of investors.”

To save the dollar, the Fed will begin to raise interest rates, precipitating a reduction in stock market and precious metals values. When? My guess is Feb – March.
More foreclosures esp for variable rate mortgages !

Posted by chaz | Report as abusive

“Other then high inflation due to devaluation of dollar, this will also lead to less US influence in the world. US strength does not stem from its military might but from its consumer base.”

US strength stems very much from its military might as well as its economy, which is far more than just its consumer base. The U.S. could import dramatically less and still be the single largest export destination for global exports. These are RELATIVE changes. The U.S. will necessarily lose some relative influence versus other nations, just as it has been doing since the end of WW2. This is a completely different universe from the U.S. losing its influence.

“Now if US becomes a net exporter or a big enough exporter (compared to its imports), its buyer nations would have the same leverage.”

Being a net exporter gives a nation influence as well. China is dependent on the United States for its economic stability, yet that does not keep it as being portrayed as being in the driver’s seat. The reality is dramatically different, of course, but this is a situational issue. Narrowing the current account deficit (which has already, by the way, fallen to around 3% of GDP from a peak of over 6.5% literally just a few years ago) has value for the United States. Narrowing its trade surplus will have value for China.

Thanks to journalism not unlike this article, people are living in a world of rhetoric without hard numbers. “Decline,” “demise,” “end of the dollar,” doomspeaking in general for the U.S. It’s mystifying.

“What is the interest on ten trillion dollars at say, 8% and where will the dollars come from to pay that interest?

8% is radically high, and that’s not how things work with this kind of debt. It should also be pointed out that the majority of U.S. debt still is owed to domestic entities.

Posted by Michael | Report as abusive

This was the plan from the entire get go. Use America to destroy America. The central banks are replacing the dollar with a basket of currencies called SDR. Special Drawing rights. The globalist are almost done seizing America and now the American citizens are about to be destitute. All this country had left was the dollar. We have no manufacturing base, we hardly produce anything at all. Service sector jobs, government jobs and casino jobs, don’t produce anything. They just take money from someone or just shovel existing money around. The people that you call conspiracy theorist were right all along. The plans were right out in the open but the public was to dumbed down to even recognise it and stop it. They just got fat, cheered for illegal wars, ate poisons foods that gave them heatlth problems and watched football. Bravo New World Order, Bravo. :-(

Posted by Sammy | Report as abusive

The americans thought they can have the world by practically buying it with monopoly money called american greenbacks. Thanks to several reasons including lack of fuel for their military, industry and civilian society, this may no longer be possible. More junk money anyone?

Most of the world’s debt is denominated in US dollars. When earnings fall and borrowing slows down, to pay back what they owe, people will be demanding US dollars. To pay back debt, they will have to sell everything except US dollar. When the debt to the banks is paid back, money will dissapeaper into thin air just the way it was created. Our entire money supply of US dollars was borrowed from the banks. It is NOT printed money. It is borrowed bank credit. And bank credit can deflate. Before Bernanke really prints money, expect another round of deflation to hit the economy. Debt was inflated for 50 years, it won’t dissapear with a small crash. It will take time. This is why all the money printing by the FED is not causing a blip in inflation. Debt levels are too high to inflate. When deflation occurs, USD will go up simply because debt is denominated in USD.

http://www.tradingstocks.net/html/inflat ion_deflation_credit_bub.html

Charles Dickens said it best in David Copperfield: “if a man had twenty pounds a-year for his income, and spent nineteen pounds nineteen shillings and sixpence, he would be happy, but that if he spent twenty pounds one he would be miserable.”

This quote has two interesting aspects. First, it explains why the United States is so miserable. But more importantly, it says worlds about what happens when a reserve currency collapses. How happy could you be on twenty pounds a year today?

Well, to all of those “America will be a service economy” folks – thanks for this.

It is becoming obvious (finally) that our trade deficit is at the root of this whole economic meltdown.

Business was stupid to think that power will stay with those who make nothing and only consume.

Manufacturing and technology are a nation’s muscle. They are (and were) the only reason anyone would want to sign up to our program. Technological and Industrial superiority were testimony to our credibility.

Who has more power: the guy who has money or the guy who has stuff? Try eating money.

We need an American Industrial Renaissance NOW!

Posted by usaguy | Report as abusive

“The americans thought they can have the world by practically buying it with monopoly money called american greenbacks. Thanks to several reasons including lack of fuel for their military, industry and civilian society, this may no longer be possible. More junk money anyone?”

There’s nothing in this comment with a shred of relevance or basis in reality. Lack of fuel for the military, industry and civilian society? I sincerely do not understand how people become so wildly uninformed or misinformed.

This problem has been brewing for 15 years, and it will run it’s natural course.

We send way to much money overseas to buy gas, support foreign goverments, etc, and we borrow money directly and indirectly to finance it all.

Contrary to the popular belief America can borrow to it’s heart’s content, it’s growing closer and closer to the time to pay the piper.

Only once the dollar is devalued so much we can balance what we export, with what we borrow from overseas, and only when we get to that point over the long term, there will always be stress against the dollar, lowering its strength against other currencies.

Posted by Robert | Report as abusive

The dollar was the signature mark of the American age. The downfall of the dollar is not by any foreign economic power but by our own leaders. Just like past Empires impermeable to outside forces the downfall comes from within.
The fearful aspect is that President Obama did not do this because he was naive, as he is an ivy league graduate. I believe his deep rooted far left wing Socialist philosophy that borders on being a neo- communist has influenced his decisions to take down what he sees as an oppressive economy and a racist culture.

I have no doubt that President Obama sincerely believes that the free market system is evil and a government controlled economy is the best alternative. I also believe that he sees past American foreign policies as wrong and an apology is in keeping. This new government is willfully and with full sense taking apart what they see as evil and unfair and by their actions they believe that the average American needs taking care of, that we do not know what is good for us except them. That may explain why so many Congress men were taken by surprise by the ferocity of the town hall meetings and meant when they accused us as “nazis” “thugs”, and other derogatory terms for they actually see us as such. That may explain why Barbara Boxer dressed down a General for not addressing her as a Senator, or Obama’s tongue lashing at General McCrystal for speaking the truth.

As Judge Sotomayer stated she is the “wise Latina” and in keeping our government officials we elected believe they are the enlightened ones facing an ocean of unwashed ignorant masses.

Since high school we are taught of the three branches of government: the executive, legislative and judicial. But the fact is there are a few more. The main (fourth) branch is the electorate, and the fifth branch is the military. One even could state that the media makes a branch onto itself.

Taking this into consideration, a military take over may become plausible as our present government goes all out to dismantle the US culture, her economy and destroy her image abroad.

Posted by Asian view | Report as abusive

This problem has been brewing for 15 years, and it will run its natural course.

We send way to much money overseas to buy gas, support foreign goverments, etc, and we borrow money directly and indirectly to finance it all.

Contrary to the popular belief America can borrow to its heart\’s content, it\’s growing closer and closer to the time to pay the piper.

Only once the dollar is devalued so much we can balance what we export, with what we borrow from overseas, and only when we get to that point over the long term, there will always be stress against the dollar, lowering its strength against other currencies.

Posted by Robert | Report as abusive

All good points, but weren’t they just as true a few years ago when the euro, for example, was worth about 85 US-Cents? Nobody cared back then.
Isn’t the reason for the most recent weakness of the dollar just simply the carry trades?

Posted by wu_trax | Report as abusive

So if the dollar drops like a stone. We will have hyper-inflation and high interest rates but other countries won’t want to finance our debt. That might not be bad? -If we can help our elders and preclude other countries from the purchase american assets.

If the dollar is strong we will ship jobs overseas, have highier unemployment, highier imports and lower interest rates (at least for some)

I’ll go for door number 1 monty.

Posted by kit | Report as abusive

“There is also the possibility that globalization has permanently raised the “natural” level of the U.S. current account deficit. Huge swaths of the U.S. manufacturing base and a growing wedge of the country’s service sector have been offshored or simply moved out of the U.S. Many of these goods and services are still consumed by the U.S., but now much of the money generated by those sales will be the result of dollars being sold to buy pesos, ringgits or yuan.”

And, this is exactly one of the reason why unemployment rates are getting to the point of ridiculous, now. Since the bulk of the manufactured goods have been coming from China–and services from India–the United States basically subsisted on land development and construction. That is the only reason why things didn’t go belly-up much sooner than now. But, as soon as the real-estate market started drying up, all these people lost their jobs, leaving no options aside from an underpaid service sector that fast filled any empty positions.

An example, a large appliance manufacturer had 60,000 employees on the payroll in their US factory. Ten years later, they have only 3,000! That’s a 95% layoff rate. Absolutely amazing.

While we are encouraged to “buy American”, it’s not even possible, anymore. That is–unless you are buying a car. And even that’s changing with GM accepting billions in bail-out money. And the thanks the American public gets? Closing all the US factories and offshoring the manufacture of their automobiles to China. They should have been required to keep those US factories open, accepting the bailout.

Just my thoughts…

–Robert

Posted by Robert | Report as abusive

well, they should get rid of pennies, but the issue we are facing is getting rid of the dollar. i agree that i should be kept, and it is an american symbol. but i head that the dollar is actually only 38 cents right now,. thats how pathetic it really is.

Posted by jane | Report as abusive

My daughter asked me the other day how can Denmark afford to have excellent free medical treatment to their citizens and other social programs. I answered her: “How many super-aircraft carriers does Denmark own? How many ballistic missile submarines does Denmark own? How many troops does Denmark have in Iraq? How many fleets does Denmark have sailing the oceans?” “None.” said she. And that is why Denmark can afford these programs.

America should pack-up and go home. Tell Europe, Asia, and Africa it has been fun; but you are on your own now. Good luck and thanks for all the fishes.

Posted by WRTolkas | Report as abusive

The dollar use to be as good as gold worldwide.
Just like every country that has ever printed more and more money our dollar is now or soon to be worthless.
Our country is so much in debt eventually every dollar we worked our whole lives to save will continue to become worthless. Even the super wealthy will be in soup lines.
There is only 2 ways to solve this problem, tax breaks for people and companies that make $30,000 and up and get government and regulation out of everything possible.
Yes this is the opposite of Obama’s Markism but it works every time it’s tried.
Follow the lead of our forefathers to the letter.
They had the wisdom to know that more government will be the downfall of our GREAT nation.

Posted by Mike | Report as abusive

Hi,

If I am not mistaken I think the basic argument here is that Americans tend to consume more than they produce, which cannot continue forever. To be frank, I think America has a consumer mentality, which doesn’t work in the long term.

Cheers,

pc :-)

Posted by pc | Report as abusive

Sammy, the US still manufactures more goods in dollar volume than any other country on earth. It is projected that China will pass us, but it is inaccurate to say that that “we have no manufacturing base. We hardly produce anything at all.” I’m concerned as many of these commenters are, but if we are making life and investment decisions based on facts, lets make sure we have “real” facts. About manufacturing and everything else.

Posted by Thomas | Report as abusive

Agree with pc. Too many people bought too many things with credit cards and now almost everyone I know is in some credit card debt. Too many people wanted that house to own and signed a mortgage without considering how they will pay for it long term and now they’re losing their houses and devaluing the houses of their neighbors. The consumerism mentality just got out of control.

Posted by bob | Report as abusive