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. )

64 comments

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The US dollar deserves to continue to decline.
Why?
Well Mr Benanke and co are more watching hedge funds return to 20-30% annual returns with his very low interest rates and printing money.
Whilst anyone working hard and saving cash gets what?
Mr Benanke kindly gives you 1%. How does he look at himself in the mirror every day
When will the central banks around the world stop rewarding excessive risk takers

Posted by gd | Report as abusive

Consumerism is not the problem. The problem is the US government borrowing trillions and trillions of dollars from other countries to finance our out of touch national budgets.
We need to face up to the fact that we can’t afford the myriad of social welfare programs we have and we have already dug ourselves into a huge abyss just trying to keep paying on the promises of social security, medicare, medicaid, etc….
Bottom line is, we need to cut back federal spending to LESS than what the country collects in taxes every year, instead of spending 3 to 4 times more than what we are collecting in taxes. And just raising taxes won’t work, that will supress business even more.
The federal government has become a goliath, and now our leaders in Washington DC want to make it even bigger, and spend like never before, despite the fact that there is no money left to spend.
It’s complete insanity. We need to get this thru our collective American heads. WE CAN’T SPEND MORE THAN WE COLLECT! I know that’s a difficult concept to understand. Look around, our currency is collapsing, our economy is collapsing, and at the same time, we are passing and in the process of passing gargantuin socialist spending bills for social welfare programs.
Understand this. There will be NO PROGRAMS AT ALL, once the we are totally bankrupt and no one will lend us anymore money! Those are the cold hard facts.
We need to re-take the government, tighten all our belts as Americans, and turn things around.
This will be increadibly difficult for all of us, but if we don’t do it, we are headed for disaster.
No one will want to have cut backs to what they are currently getting from the government, but it has to happen. Again, we can’t spend more than we make! This is what has put us 11 Trillion dollars in debt!
We need to cap spending at 70% of the GDP, and dedicate the remaining 30% to repaying the debt. We also need to get real and realise that some of the artificially high wages that are being payed here in the US simply no longer fall in-line with current world realities. Yes it’s nice to make $65 dollars per hour to fasten seat belts to the pillar of a GM car, but when the car company that makes that car goes bankrupt, because those type of wages don’t allow that manufacturor to be competative on a world wide basis, then what good did it do to aftifically keep that wage that high? Considering that the US taxpayer has had to bail out the manufactor that pays that kind of wage more than once, then you need to realise that we are ALL paying the price for that “out of touch” and un-realistic wage, that doesn’t reflect current worldwide realities.
1- cut our spendind to 70% of GDP (it will hurt but it must be done)
2 – start paying off our national debt, and pass new laws banning the federal government from spending beyond our allowable budget other than in cases of national emergency or catastophry.
3 – Stop bailing out corporations that are going bankrupt because they pay un-realistic wages in line with current worldwide conditions. Let them go bankrupt, which will cancel all current wage contracts. New companies will spring up to replace them and wages can be payed according to current realistic conditions, which allow new companies the type of profit they need to invest in better technology, remain profitable, and be competative price wide on a world wide scale with their products.
4 – Realise that no matter how good your intentions are, only a certain percentage of the GDP can go to social welfare programs. The worst thing a country can do, is start to borrow and go in debt, just to keep social welfare programs running. That is the clearest sign that the experiment just doesn’t work.
No one will have any programs when the country is bankrupt anyways right? So then, doesn’t it make more sense to only spend what is available, and according to a budget that doesn’t inccur deficit spending?
Why should this be such an increadible thing to understand? lol
5 – Shrink the federal government by 40% of its current size, cut taxation rates on business and those who generate jobs, fire the federal reserve and take back our currency.
Do those things and watch the biggest economic boom in the history of our nation happen, a recovery of the US dollar, a re-emergence of the US as a manufacturing nation, and record economic surpluses, as the US regains its ability to compete in the world markets.

Posted by ShaneUW | Report as abusive

it is inaccurate to say that that “we have no manufacturing base. We hardly produce anything at all.” That is a valid comment and for that reason we have to keep the keep the war machine running. A new war is urgently needed for a solid recovery.

Posted by bachu | Report as abusive

To WRTolkas: you appear to be unaware that after the US and the UK, Denmark (population of only 5 million) had the largest contingent in Iraq – in proportion to population, more than the US. It also has a substantial contingent in Afghanistan,where many Danish soldiers have died. So much for supporting the troops! In addition, Denmark has one of the largest merchant marines in the world – roughly 30% of the supplies shipped to the US military in Iraq came in via Danish carriers.

Denmark can afford its expensive social programs not because it’s propped up by the US – which has no troops here – but because Denmark’s citizens pay high taxes to support them. In turn, they can afford to do that because the economy is robust (the recession was mild and is already over here) and employment is high (unemployment is a fraction of that in the US and has been that way for many years). Last of all, they can afford it because successive governments here have kept a tight rein on spending. Through most of the last decade, we have run surpluses, not deficits – and the government has used those to pay down debt.

Over the last decade, US federal debt has climbed from 50% of GDP to over 100%. In the same period, Danish government debt has fallen from 60% of GDP to 15% – and that’s at the same time as they support those social programs. There’s a similar difference in privately held debt. Basically, the Danes (and other Scandinavians) didn’t go on a spending spree when the economy was good – instead they saved and invested against the day when the economy would be not so good.

*That’s* the sort of thing that’s driving pressure on the US dollar, not some mythical transfer of wealth via military infrastructure.

cheers, Mark

Posted by Mark | Report as abusive

The US has for the longest time created an environment for parasites (people on public assistance)to grow. Now I know there are people on public assistance that actually deserve and need it, but, there is a large percentage of people on it that could well do without it. Our politicians are going to have to come up with some restrictions to thin the parasites out……… People and corporate parasites.

Posted by harold | Report as abusive

What happened to the wonderful SERVICE ECONOMY that was supposed to have replaced the dirty manufacturing and industrial economy? I guess that was all hot air by scumbag attorneys turned politicians and contributed more to Global Warming than actually creating jobs and prosperity!

Posted by Schumann Rafizadeh | Report as abusive

Having a little trouble understanding how trade imbalance caused all of this?

Here’s a simple (but accurate) explanation:

After a currency debacle in 1998 left its economy in tatters, Beijing decided to radically restructure its financial relationship with the West. Policymakers pegged the value of China’s currency to the dollar, which had the effect of keeping it artificially low.

The cheap renminbi made it irresistibly inexpensive for U.S. companies to manufacture goods in China, even after shipping costs. As more companies shifted their operations to China, the U.S. manufacturing base was hollowed out in the name of globalization and profitability. Americans who once enjoyed high-paying factory jobs moved on to lower-paying service jobs.

China didn’t need much of anything made in America, so instead of buying cars from Detroit and furniture from North Carolina with its factory profits, it bought Treasury bills. The purchase of all those bills drove down U.S. interest rates. So as middle-class and blue-collar Americans saw their wages stagnate or decline, they discovered they could still keep their old lifestyles by borrowing.

Over the past decade, Americans were able to outspend their incomes by easily rolling their debts forward through serial home refinancing. The situation was never ideal, but it worked as long as the value of their collateral — their homes — kept rising.

As long as China kept buying Fannie Mae (FNM, news, msgs), Freddie Mac (FRE, news, msgs) and Treasury credits, the scheme worked in a strange and beautiful way: Our driveways filled up with cars and boats, shopping malls spread out across the suburban landscape, and the retailer with the closest ties to China, Wal-Mart (WMT, news, msgs), became the United States’ largest company.

Posted by Willis | Report as abusive

Folks, get ready for the one-world government. Devaluing the dollar is one of the final steps toward realizing this monstrosity. The North-American Union, the merge of Canada, the U.S., and Mexico into a super-economic (and ultimately governmental) power, is the next step. Our national sovereignty will be destroyed. I urge readers to get a copy of Jerome Corsi’s America For Sale.

Posted by Mufaso | Report as abusive

Mark said:
“Denmark can afford its expensive social programs not because it’s propped up by the US – which has no troops here – but because Denmark’s citizens pay high taxes to support them. In turn, they can afford to do that because the economy is robust…”

Not exactly – where do you think the Danes get the money to pay for those social programs?

The U.S. has a $3.28 billion trade deficit with Denmark. The U.S. is everyone’s biggest trade partner and we a have a deficit with just about everyone.

Indirectly, WE are paying for Europe’s social programs.

All of these happy little European Socialist states can maintain their nanny-ness because they are all attached to America’s big dirty Capitalist Economy like parasites.

If the U.S. went socialist – the Global Economy would fall apart. Socialism needs to sell to a Capitalist economy to survive.

Posted by Jones | Report as abusive

The reason the dollar is dropping in value is more due to the fact that in the world economy –(where all the different currencies of each country are balanced out and each currencies worth is put against the other.)– has changed ever since the advent of the EURO <– which took away nearly 50 currencies in Europe, the dollar has been dropping. they basically tranformed their entire continent into one big economic powerhouse and it worked for them instead of us being rich now they are because our dollar has to compete against the EURO as a whole as opposed to the many different currencies there used to be It has nothing to do with welfare or obama (although printing <-new money- our way out of debt like his administration is trying to do is why the USSR collapsed).

Posted by Martin | Report as abusive

I would be interested in seeing what the components of production, imports, consumption and exports are for the US. Maybe a long journey downward will be a pleasant one, like a tired old 737 jet coming in for its last landing to be replaced by a zippy new technology and way of thinking.

Posted by Casper | Report as abusive

There’s so much talk of late about the dollar falling, it surely follows that somebody has a vested interest in seeing it go that way. One doesn’t have to look too hard to figure out who might be involved. [Hint: it's not who it should be.]

Amid all the chatter, what seldom gets mentioned is the degree to which our currency policy now quivers coyly in the hands of an unregulated US finance industry, rather than those of the Treasury.

Underpublicized also are the long-term risks of this presumptuous trend toward total privatization of the national interest. It’s been going on so long now, it’s just “one of those things”.

With the Treasury Department devoting obscene amounts of its time and resources to massaging certain parts of private financial services industries in a suspiciously sensuous fashion, instead of focusing on the vast and troublesome domestic implications of an unruly greenback’s mood swings careening entirely out of public control, the overall situation becomes that much more volatile and vulnerable to catastrophic outcome.

Clearly this concerns the banks not one whit. Boldly using taxpayer funds as gaming chips, you’ll see them short the U.S. Dollar wholesale in a New York minute. And damn the consequences – as long as they come out ahead on paper, they really don’t give a hoot how low the domestic currency sinks and at what inevitable cost to the American public.

Europe On $500 A Day, anyone?

(At the time of publication the writer didn’t seem to have too many dollars.)

Posted by The Bell | Report as abusive

Thank you for the article.

Posted by enoch apaibinyesim | Report as abusive

So much of this discussion is overblown. The U.S. is the most innovative and hard working on the planet. Our currency is the most transparent and trusted. Period. Until China can produce something other than the plastic garbage sold at big box stores and the EU has a longer work week (and ends its bickering), the USD will continue to be the currency of choice. Another point, oil’s influence on the USD stops when we find transparency (working according to the EIA)- or an alternative abundant and practical energy resource.

Posted by Matt | Report as abusive