The US Dollar Is Not Weak

In 2004, The USD Was Falling, But the Dollar Wascurrency traders are jumping to the wrong
Never Weak!Germany's long term economic policyconclusions about the USD, and we will see in the
has been to cultivate a permanent trade surplusevent, opportunities open up for us to profit from
by saving more, and consuming less. But there isbeing on the other side of the trade, that is, long
another side to their trade surplus/high savingsthe USD. The question for currency traders is
rate story. Growth in Germany is 1/3rd that in"When to buy the USD, not 'if'."A Reality Check
the US, while unemployment is double,Of The Bearish USD Analysis Does Not "Bear
productivity is similarly a fraction of what it is inUp"For those who say the dollar's decline should
the US. High taxes, over regulation, and a pensionbe understood as a reflection of an economy
system that is in deep trouble, are costs thatburdened by structural weakness {and there are
contribute to the broad structural deficiencies thatmany prominant economists who do}, as
hold the German economic machine back.Thisopposed to a currency that is in a cyclical move
comparison of the leading economy in euro landlower, then it would seem that the structural
with America is an over simplified attempt to calldefects which dollar bears allude to must be able
attention to the importance of understanding theto "bear up" under a reality check. We know the
dynamics behind a country's strengths andUS economy has grown at 4% in 2004. We also
weaknesses which, in the end, are reflected inknow that between 1974 and 1994, productivity
currency values. So the Euro has been rising andwas about the same as in the eurozone
the USD has been falling. What gives?For starters,now--1.5%. But with the onset of the productivity
I believe we all can agree that the Euro's rise isgains from US corporate investment in IT
less a story of Euro strength and more really abeginning in 1995, US productivity has more than
story about the dollar's fall. Dollar bears argue thatdoubled for the last decade, and in 2003 and
long overdue structural reforms in the US need to2004, printed 4% gains, almost triple euro land's
be embraced now, and they point to a loominglevels.Even though the Federal Reserve policies on
6% trade deficit, as well as other issues that nowinterest rates gave US borrowers real negative
seem to be threatening a disorderly collapse ininterest rates, inflation in the US is as low as the
USD values worldwide. My point of view is thateuro zone's is--2%. So on balance, we see the
the USD fall has been, bottomline, in a cyclicaleconomic foundation of the USD neither defective
move lower from a previously over valued level innor needing reform. The US economy has low
2002 when the Euro was only worth 85 cents.Atinflation, soaring productivity and high economic
this point the next long term move in the dollar isgrowth, all much better than historic trends, and all
in large part dependent on the answer to oneare projected to maintain those levels for as far
question:Does the US need structural reforms, oras the eye can see. Of course, unemployment, is
is it the other nations of the world who are undermuch lower than the eurozone, and trending
consuming and under producing that needlower. But what about these structural problems
structural reforms in order to restore balance towithin the US?Low Savings RateThe savings rate
the global economy and to currencies as well?In afigure is the simplest of statstics to explain and
modern environment of economicunderstand. Accountants add up total wages
interdependence, money flows from around theearned, subtract consumer spending and what is
globe increasingly affect individual, corporate andleft over they call "savings." This savings rate
national wealth through nothing more than thenumber as a measure of consumer wealth,
changing value of currency relationships {forex isconsumer income, or even as a loose
a $1.3 Trillion/day market}. Currency traders whoapproximation of consumer financial status in the
understand the dynamics behind these changingUS is only a small piece of the puzzle, and has too
foreign exchange values will profit consistently andoften been used in a misleading way.You cannot
substantially. Those who have drawn the wrongassess savings in America without factoring in
conclusions about the underlying forces ofhousing. Three out of four Americans own homes
currency valuations are destined to be on theand like the overall American economy itself, the
wrong side of currency trades and their losses willUS housing market has been rising at an historic
enrich those who have been right!In today'space. The move up has been so strong that
foreign exchange environment one currencyhousing sales and price levels continued to print
continues to occupy centerstage as the world'snew highs right through the economic recession of
reserve currency--the US dollar. Gold and oil are4 years ago.And even the much talked about
priced in dollars. The dollar is involved in 85% of all"wealth effect" in the pre-recession, pre-bubble
currency transactions {Euro 37%, Yen 16%} andeconomy in the US it turns out was mostly a
central banks the world over accumulate dollarsbenefit not of stock market gains leading up to
as a necessity for stablizing the exchange valuethe March 2001 bubble, but of appreciation in
of their respective national currencies. Offshorehousing values and mortgage refinancing at
central banks finance over 50% of the US tradehistoric low interest rates {which generated
deficit that way. Three out of four dollars now inwidespread "cash outs--cash payments after
circulation are held overseas. And today as werefinanciing because of the much lower interest
see the US dollar falling farther and farther, werates}.So it turns out that even though there was
know that the rising price of gold and the recentan equity market bubble, and a recession in 2001
$50+ price of oil are{not to mention the World Trade Center attack},
each in great measure reactions to this currentnevertheless the booming economic structure in
and anticipated further decline of the USD. In factthe US was solid, built as it was on new higher
Saudi Arabia is letting it be known that it plans tolevels of productivity from IT, housing wealth and
adjust the new baseline price for its oil up fromlow inflation. The recession, precipitated by the
$25 to $35. Saudi Arabia has also been sellingFed's higher rate policies was, as I noted on my
some of its dollar reserves in favor of the euro.radio show at the time, a "good recession" and a
There have been stirrings that China is substitutingnecessary one brought on by the over
the euro for some dollars in its huge cash reserveexhuberance of an economic and investment
accounts. Net, net, if markets see this trend"boom" underlying the US economy. Fed Chairman
continuing, the USD is certainly headed still lower.Greenspan has said the reason he raised rates
There is also more and more credible talk thatwas because businesses were investing too much
the euro will replace the dollar as the world'sin high tech and at an unsustainable rate. In other
reserve currency. After all the Euro now has awords--the US had too much of a good thing. High
20% stake as the reserve currency of choice byproductivity, low inflation, robust consumer
the world's central bankers, up from 13% a shortspending and the US's growing home ownership
time ago.Counter intuitively, we find theprofile are not structural defects for any
strengthening euro is not a welcome developmenteconomy, they are the things every economy
throughout much of europe and the world. Indeedseeks to affirm its strength.Now as 2005 begins
today as we begin 2005 and find the Euro atand with the recession far behind it, the US quite
historic high levels, up fully 50% from its lows ofclearly presents itself as an economy that is
2002, German Chancellor Gerhard Schroder isstable and poised to consolidate its upward
saying the new level of the Euro is worrisome forgrowth track, and with that will go increased
the German economy. The French Foreigndemand for her currency, the US dollar.Which
minister is calling for an international conference toLeads Us To The Trade Deficit.As someone living
develop coordinated policies {read intervention} toin America, I have confirmed for you that for
staunch the Euro's climb against the dollar. ECBover a decade Americans have been living in an
President Issing is troubled and has asked europe'senvironment of low inflation, dramatically
consumers to start spending to help the eurozoneimproving unemployment, low interest rates,
avoid recession.And europe is not alone inskyrocketing real estate values, strong economic
concerns about their currencies' suddengrowth and an IT revolution that offers falling
appreciation vs the USD. The Japanese Yen is upprices on many of the latest and most appealing
25% and in reaction, Japan spent $147 billion in thehigh tech recreation and entertainment products
first quarter alone of last year selling its Yenavailable from all over the world. Imports from
mostly for dollars in another of its periodic andforeign sources have been low priced thanks to a
futile attempts to manipulate currency values.strong dollar monetary policy in the US and taxes
China is poised to raise its Yuan's peg with thehave been on a declining trend. One has to ask
USD since the dollar's decline has dragged thethe dollar bears, "Why wouldn't the American
dollar-pegged Chinese currency lower with it andconsumer spend and buy more and more
the falling Yuan now threatens to ignite inflation inimports?" With interest rates at historic lows,
China's already over heated economy. So as thehousing wealth fueling personal savings {though
Euro, Yen and other international currenciesnot counted as savings in the savings rate},
continue their rise in value as a counterpoint toinflation low and low priced imports from europe
the dollar's decline, there are economic costs atand asia abundantly available, it would be odd if
work.It seems that in practice the world over,they weren't spending, and given the moribund
international economies, but not always theirgrowth in Japan and Europe, the 2nd and 3rd
political leaders, prefer a weak dollar. Indeed, in alargest economies in the world, it would be
chorus that has grown stronger of late, the globalimpossible for the US not to have a trade deficit.
political community is increasingly lamenting howAmericans are major importers for the world and
our new era of globalization has become far toothat fact contributes mightily to international
US-centric, and calls have become more urgent toeconomic growth, but it also leaves America with
fix a serious global imbalance. The source of thisa trade deficit.So bottomline? The call for
global imbalance of course must be America! "Theconsumer demand to retrench in the US is a call
US consumer is consuming too much, he needs tothat will never be heard. It is like whistling in the
stop that!"Indeed, the emerging consensus in thewind. It is not going to happen, and further, a
popular and financial press which after studying alllarge trade deficit must be understood as "part of
of this has announced that there are 3 reasonsthe bargain" resulting from a strong consumer
for the USD move lower since 2002, all pointingdriven US economy which is also stimulating global
to the US. Too much consumption {leading to aeconomic growth. Don't forget, the international
record US trade deficit} with its flipside, a loweconomy is US-centric because of the US
domestic savings rate. And third, the US tradeconsumer.Finally, let's look at the federal budget
deficit's twin--a growing government budget deficitdeficit in Washington.The US government budget
has become a dollar negative and is nowdeficit is an easy issue to evaluate in terms of its
contributing to a precipitous erosion in demand forrelationship to currency values. To begin with, the
the dollar.There is an abundance of opinion amongbest, most informed estimate of future tax
those who follow currency markets that indeedrevenues needed to balance congressionally
the fall in the dollar is due to these kinds ofappropriated expenditures is reasonably accurate
structural issues that call out for America tofor at most, 60 days out. Budget deficit
reform. America must consume less, raise taxesestimates have a notoriously short shelf life!As
and save more. And so their answer to thethe 2005 fiscal year began in October, 2004, the
question, "Is the USD weak?" is an emphatic yesonly thing that was certain is that the real budget
because the US economy's structure isdeficit will be no where near its original working
weak!There is A Different Opinion!The one thingestimate. It never is! The Congressional Budget
to remember about currency markets is that justOffice, the White House Office of Management &
like water, they seek their own level. TheyBudget, and every economist who follows federal
inevitably find a balance and these protestsbudgets, none of them projected the budget
against the Euro's strength suggests to me thatsurpluses of 2000/2001. Indeed, most
the Euro is not quite ready to step up andcontemporary estimates were being changed
dislodge the USD as a replacement in the globalweekly during that period, as tax revenues
scheme of things for right now. It also suggestsexploded from the hot US economy at that
to me that the dollar's decline is cyclical and thetime.That being said, the idea of a balanced
USD therefore, even though it is falling, is notbudget is a principle that the US should embrace.
weak.Nevertheless, there is reason to believe thatThe 2005 budget at a projected deficit of $500
markets are increasingly seeing the USD as nowbillion will pressure interest rates in the US higher.
at a permanently lower plateau than in the past,But higher interest rates are USD positive. On the
and I agree. So let's revisit the pivotal question forother hand, a $500 billion deficit will increase the
currency trader's. "Is the USD weak, or is it fallingneed for higher taxes, which subtract from
in a normal cyclical adjustment?" We need to looksavings and investment growth, and so that is
closely at what is behind this dollar's move lower ifdollar negative. But then we have to think about
we are going to be ahead of what's happening inhigher taxes which is what the dollar bears are
the currency markets in 2005 and understandprescribing to strengthen the dollar and help the
these dynamics so we can then profit in currencyUS address the issues they see dragging the
trades. Note:The Federal Reserve US dollar indexdollar down, and so higher taxes from their
of 26 leading currencies ranks the dollar's declineperspective are dollar positive!I want to note that
from Feb. 2002, at 14%. That was from whatit actually would be dollar positive, and significantly
many consider to be an overvalued level with theso, should the US congress adopt a "paygo" rule,
Euro trading at less than 85 cents per dollar atlike it had when the congress posted the
one time. Today this basket of currencies showssurpluses of a few years ago. The Paygo rule
the USD at the same level it was in 1994! Inrequires an offset in any new discretionary
other words, it is in sync with past USD cyclicalspending from either an increase in taxes or
moves lower.Despite the many statistics thatreduction in other spending, thus maintaining a
show current USD valuations within historicalstricter discipline over the budget. If the markets
ranges, many governments, political leaders,were to see a balanced federal budget in the US's
economists and currency traders believe the US isfuture, they would anticipate more investment in
facing a crisis and must balance its trade account,the US and at lower interest rates and that will
reduce consumption at home and return to theattract buyers to the USD.The truth is, that at
balanced federal budget it had in 2000-2001. In thethe end of the day a balanced budget is dollar
absence of such reforms, the US invites apositive while budget deficits affect the dollar
disorderly collapse of the dollar which is certain toexchange rate only in a marginal way, so long as
lead to global economic chaosFrom the point ofthey exist in an environment of strong growth
view of the international political community higherand low inflation, which we find in the US currently.
taxes would be an ideal answer and contribute toWith declining unemployment and a base of high
all three remedies. They would reduceproductivity we can discount the federal budget
consumption and thus help the import skeweddeficit at these levels in terms of significantly
trade deficit plus also help point toward a balancedaffecting USD currency values.So it is quite
federal government budget! They want to seeapparent here in my "World of Currencies," that
taxes raised, consumers spend less and a slowerthe structural strength of the US economy
growth rate in the US. It sounds like they wantpreempts a disorderly dollar collapse crisis that
the German experience as the model for the US.dollar bears project. Apart from that, the
Dollar bears and their adherents are prepared tosupposed structural causes of the USD's decline,
short the USD until they can begin to see theirits trade deficit, savings rate and government
remedies finding traction in the US economy. Butdeficit are non starters as targets for reform,
currency traders who buy into these prescriptionsand more importantly, not structural weaknesses
will be on the wrong side of the USD trade in theafter all. Forcing the American consumer to spend
long run. Dollar bears as they continue to sellless through higher taxes would wreck the US
dollars will have a long wait for any profits ineconomy and in the process derail global economic
anticipation of a collapse of the USD.As a resident,growth. The global imbalances from an admittedly
citizen and student of the American economy, IUS-centric international economic environment are
can tell you, neither the trade nor budget deficitsreal, but they can best be addressed by greater
in the US are going into balance anytime soon.consumption and other structural reforms in the
More to the point, barring a catastrophe, it isinternational community of the sort the German
virtually impossible to see them doing anythingmodel is resisting. The two points of view about
more than narrow marginally. The domesticwhere reforms must occur next are in fact, the
savings rate similarly is not going to rival thetwo sides of the USD trade.The market will
eurozone's 9% level, nor Japan's 6% for thedeclare the bottom for the USD as soon as it
foreseeable future. In fact, unless the Americanfinishes making up its mind of how low that
shopper miraculously morphs into a parsimoniousbottom should be, given its new recognition now
European or Japanese clone {something that isof the permanent status of a large US trade
not going to happen}, the annual Americandeficit.. The Eur/USD level of $1.40 and USD/JPY
savings rate will not be surpassing even 3%of 100 Yen, may not be the low point for the
anytime soon from its current 1% lows.Quicklydollar, but if theyare not, they are awfully close.
let's look at each one of these "concensus"The USD is falling, the US dollar is not weak!
causes for the USD's fall and learn why so many