| In 2004, The USD Was Falling, But the Dollar Was | | | | currency traders are jumping to the wrong |
| Never Weak!Germany's long term economic policy | | | | conclusions about the USD, and we will see in the |
| has been to cultivate a permanent trade surplus | | | | event, opportunities open up for us to profit from |
| by saving more, and consuming less. But there is | | | | being on the other side of the trade, that is, long |
| another side to their trade surplus/high savings | | | | the 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 in | | | | Up"For those who say the dollar's decline should |
| the US. High taxes, over regulation, and a pension | | | | be understood as a reflection of an economy |
| system that is in deep trouble, are costs that | | | | burdened by structural weakness {and there are |
| contribute to the broad structural deficiencies that | | | | many prominant economists who do}, as |
| hold the German economic machine back.This | | | | opposed to a currency that is in a cyclical move |
| comparison of the leading economy in euro land | | | | lower, then it would seem that the structural |
| with America is an over simplified attempt to call | | | | defects which dollar bears allude to must be able |
| attention to the importance of understanding the | | | | to "bear up" under a reality check. We know the |
| dynamics behind a country's strengths and | | | | US economy has grown at 4% in 2004. We also |
| weaknesses which, in the end, are reflected in | | | | know that between 1974 and 1994, productivity |
| currency values. So the Euro has been rising and | | | | was 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 is | | | | gains from US corporate investment in IT |
| less a story of Euro strength and more really a | | | | beginning in 1995, US productivity has more than |
| story about the dollar's fall. Dollar bears argue that | | | | doubled for the last decade, and in 2003 and |
| long overdue structural reforms in the US need to | | | | 2004, printed 4% gains, almost triple euro land's |
| be embraced now, and they point to a looming | | | | levels.Even though the Federal Reserve policies on |
| 6% trade deficit, as well as other issues that now | | | | interest rates gave US borrowers real negative |
| seem to be threatening a disorderly collapse in | | | | interest rates, inflation in the US is as low as the |
| USD values worldwide. My point of view is that | | | | euro zone's is--2%. So on balance, we see the |
| the USD fall has been, bottomline, in a cyclical | | | | economic foundation of the USD neither defective |
| move lower from a previously over valued level in | | | | nor needing reform. The US economy has low |
| 2002 when the Euro was only worth 85 cents.At | | | | inflation, soaring productivity and high economic |
| this point the next long term move in the dollar is | | | | growth, all much better than historic trends, and all |
| in large part dependent on the answer to one | | | | are projected to maintain those levels for as far |
| question:Does the US need structural reforms, or | | | | as the eye can see. Of course, unemployment, is |
| is it the other nations of the world who are under | | | | much lower than the eurozone, and trending |
| consuming and under producing that need | | | | lower. But what about these structural problems |
| structural reforms in order to restore balance to | | | | within the US?Low Savings RateThe savings rate |
| the global economy and to currencies as well?In a | | | | figure is the simplest of statstics to explain and |
| modern environment of economic | | | | understand. Accountants add up total wages |
| interdependence, money flows from around the | | | | earned, subtract consumer spending and what is |
| globe increasingly affect individual, corporate and | | | | left over they call "savings." This savings rate |
| national wealth through nothing more than the | | | | number as a measure of consumer wealth, |
| changing value of currency relationships {forex is | | | | consumer income, or even as a loose |
| a $1.3 Trillion/day market}. Currency traders who | | | | approximation of consumer financial status in the |
| understand the dynamics behind these changing | | | | US is only a small piece of the puzzle, and has too |
| foreign exchange values will profit consistently and | | | | often been used in a misleading way.You cannot |
| substantially. Those who have drawn the wrong | | | | assess savings in America without factoring in |
| conclusions about the underlying forces of | | | | housing. Three out of four Americans own homes |
| currency valuations are destined to be on the | | | | and like the overall American economy itself, the |
| wrong side of currency trades and their losses will | | | | US housing market has been rising at an historic |
| enrich those who have been right!In today's | | | | pace. The move up has been so strong that |
| foreign exchange environment one currency | | | | housing sales and price levels continued to print |
| continues to occupy centerstage as the world's | | | | new highs right through the economic recession of |
| reserve currency--the US dollar. Gold and oil are | | | | 4 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%} and | | | | economy in the US it turns out was mostly a |
| central banks the world over accumulate dollars | | | | benefit not of stock market gains leading up to |
| as a necessity for stablizing the exchange value | | | | the March 2001 bubble, but of appreciation in |
| of their respective national currencies. Offshore | | | | housing values and mortgage refinancing at |
| central banks finance over 50% of the US trade | | | | historic low interest rates {which generated |
| deficit that way. Three out of four dollars now in | | | | widespread "cash outs--cash payments after |
| circulation are held overseas. And today as we | | | | refinanciing because of the much lower interest |
| see the US dollar falling farther and farther, we | | | | rates}.So it turns out that even though there was |
| know that the rising price of gold and the recent | | | | an 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 current | | | | nevertheless the booming economic structure in |
| and anticipated further decline of the USD. In fact | | | | the US was solid, built as it was on new higher |
| Saudi Arabia is letting it be known that it plans to | | | | levels of productivity from IT, housing wealth and |
| adjust the new baseline price for its oil up from | | | | low inflation. The recession, precipitated by the |
| $25 to $35. Saudi Arabia has also been selling | | | | Fed'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 substituting | | | | necessary one brought on by the over |
| the euro for some dollars in its huge cash reserve | | | | exhuberance 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 that | | | | was because businesses were investing too much |
| the euro will replace the dollar as the world's | | | | in high tech and at an unsustainable rate. In other |
| reserve currency. After all the Euro now has a | | | | words--the US had too much of a good thing. High |
| 20% stake as the reserve currency of choice by | | | | productivity, low inflation, robust consumer |
| the world's central bankers, up from 13% a short | | | | spending and the US's growing home ownership |
| time ago.Counter intuitively, we find the | | | | profile are not structural defects for any |
| strengthening euro is not a welcome development | | | | economy, they are the things every economy |
| throughout much of europe and the world. Indeed | | | | seeks to affirm its strength.Now as 2005 begins |
| today as we begin 2005 and find the Euro at | | | | and with the recession far behind it, the US quite |
| historic high levels, up fully 50% from its lows of | | | | clearly presents itself as an economy that is |
| 2002, German Chancellor Gerhard Schroder is | | | | stable and poised to consolidate its upward |
| saying the new level of the Euro is worrisome for | | | | growth track, and with that will go increased |
| the German economy. The French Foreign | | | | demand for her currency, the US dollar.Which |
| minister is calling for an international conference to | | | | Leads Us To The Trade Deficit.As someone living |
| develop coordinated policies {read intervention} to | | | | in America, I have confirmed for you that for |
| staunch the Euro's climb against the dollar. ECB | | | | over a decade Americans have been living in an |
| President Issing is troubled and has asked europe's | | | | environment of low inflation, dramatically |
| consumers to start spending to help the eurozone | | | | improving unemployment, low interest rates, |
| avoid recession.And europe is not alone in | | | | skyrocketing real estate values, strong economic |
| concerns about their currencies' sudden | | | | growth and an IT revolution that offers falling |
| appreciation vs the USD. The Japanese Yen is up | | | | prices on many of the latest and most appealing |
| 25% and in reaction, Japan spent $147 billion in the | | | | high tech recreation and entertainment products |
| first quarter alone of last year selling its Yen | | | | available from all over the world. Imports from |
| mostly for dollars in another of its periodic and | | | | foreign 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 the | | | | have been on a declining trend. One has to ask |
| USD since the dollar's decline has dragged the | | | | the dollar bears, "Why wouldn't the American |
| dollar-pegged Chinese currency lower with it and | | | | consumer spend and buy more and more |
| the falling Yuan now threatens to ignite inflation in | | | | imports?" With interest rates at historic lows, |
| China's already over heated economy. So as the | | | | housing wealth fueling personal savings {though |
| Euro, Yen and other international currencies | | | | not counted as savings in the savings rate}, |
| continue their rise in value as a counterpoint to | | | | inflation low and low priced imports from europe |
| the dollar's decline, there are economic costs at | | | | and 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 their | | | | growth in Japan and Europe, the 2nd and 3rd |
| political leaders, prefer a weak dollar. Indeed, in a | | | | largest economies in the world, it would be |
| chorus that has grown stronger of late, the global | | | | impossible for the US not to have a trade deficit. |
| political community is increasingly lamenting how | | | | Americans are major importers for the world and |
| our new era of globalization has become far too | | | | that fact contributes mightily to international |
| US-centric, and calls have become more urgent to | | | | economic growth, but it also leaves America with |
| fix a serious global imbalance. The source of this | | | | a trade deficit.So bottomline? The call for |
| global imbalance of course must be America! "The | | | | consumer demand to retrench in the US is a call |
| US consumer is consuming too much, he needs to | | | | that will never be heard. It is like whistling in the |
| stop that!"Indeed, the emerging consensus in the | | | | wind. It is not going to happen, and further, a |
| popular and financial press which after studying all | | | | large trade deficit must be understood as "part of |
| of this has announced that there are 3 reasons | | | | the bargain" resulting from a strong consumer |
| for the USD move lower since 2002, all pointing | | | | driven US economy which is also stimulating global |
| to the US. Too much consumption {leading to a | | | | economic growth. Don't forget, the international |
| record US trade deficit} with its flipside, a low | | | | economy is US-centric because of the US |
| domestic savings rate. And third, the US trade | | | | consumer.Finally, let's look at the federal budget |
| deficit's twin--a growing government budget deficit | | | | deficit in Washington.The US government budget |
| has become a dollar negative and is now | | | | deficit is an easy issue to evaluate in terms of its |
| contributing to a precipitous erosion in demand for | | | | relationship to currency values. To begin with, the |
| the dollar.There is an abundance of opinion among | | | | best, most informed estimate of future tax |
| those who follow currency markets that indeed | | | | revenues needed to balance congressionally |
| the fall in the dollar is due to these kinds of | | | | appropriated expenditures is reasonably accurate |
| structural issues that call out for America to | | | | for at most, 60 days out. Budget deficit |
| reform. America must consume less, raise taxes | | | | estimates have a notoriously short shelf life!As |
| and save more. And so their answer to the | | | | the 2005 fiscal year began in October, 2004, the |
| question, "Is the USD weak?" is an emphatic yes | | | | only thing that was certain is that the real budget |
| because the US economy's structure is | | | | deficit will be no where near its original working |
| weak!There is A Different Opinion!The one thing | | | | estimate. It never is! The Congressional Budget |
| to remember about currency markets is that just | | | | Office, the White House Office of Management & |
| like water, they seek their own level. They | | | | Budget, and every economist who follows federal |
| inevitably find a balance and these protests | | | | budgets, none of them projected the budget |
| against the Euro's strength suggests to me that | | | | surpluses of 2000/2001. Indeed, most |
| the Euro is not quite ready to step up and | | | | contemporary estimates were being changed |
| dislodge the USD as a replacement in the global | | | | weekly during that period, as tax revenues |
| scheme of things for right now. It also suggests | | | | exploded from the hot US economy at that |
| to me that the dollar's decline is cyclical and the | | | | time.That being said, the idea of a balanced |
| USD therefore, even though it is falling, is not | | | | budget is a principle that the US should embrace. |
| weak.Nevertheless, there is reason to believe that | | | | The 2005 budget at a projected deficit of $500 |
| markets are increasingly seeing the USD as now | | | | billion 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 for | | | | other hand, a $500 billion deficit will increase the |
| currency trader's. "Is the USD weak, or is it falling | | | | need for higher taxes, which subtract from |
| in a normal cyclical adjustment?" We need to look | | | | savings and investment growth, and so that is |
| closely at what is behind this dollar's move lower if | | | | dollar negative. But then we have to think about |
| we are going to be ahead of what's happening in | | | | higher taxes which is what the dollar bears are |
| the currency markets in 2005 and understand | | | | prescribing to strengthen the dollar and help the |
| these dynamics so we can then profit in currency | | | | US address the issues they see dragging the |
| trades. Note:The Federal Reserve US dollar index | | | | dollar down, and so higher taxes from their |
| of 26 leading currencies ranks the dollar's decline | | | | perspective are dollar positive!I want to note that |
| from Feb. 2002, at 14%. That was from what | | | | it actually would be dollar positive, and significantly |
| many consider to be an overvalued level with the | | | | so, should the US congress adopt a "paygo" rule, |
| Euro trading at less than 85 cents per dollar at | | | | like it had when the congress posted the |
| one time. Today this basket of currencies shows | | | | surpluses of a few years ago. The Paygo rule |
| the USD at the same level it was in 1994! In | | | | requires an offset in any new discretionary |
| other words, it is in sync with past USD cyclical | | | | spending from either an increase in taxes or |
| moves lower.Despite the many statistics that | | | | reduction in other spending, thus maintaining a |
| show current USD valuations within historical | | | | stricter 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 is | | | | future, 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 the | | | | attract buyers to the USD.The truth is, that at |
| balanced federal budget it had in 2000-2001. In the | | | | the end of the day a balanced budget is dollar |
| absence of such reforms, the US invites a | | | | positive while budget deficits affect the dollar |
| disorderly collapse of the dollar which is certain to | | | | exchange rate only in a marginal way, so long as |
| lead to global economic chaosFrom the point of | | | | they exist in an environment of strong growth |
| view of the international political community higher | | | | and low inflation, which we find in the US currently. |
| taxes would be an ideal answer and contribute to | | | | With declining unemployment and a base of high |
| all three remedies. They would reduce | | | | productivity we can discount the federal budget |
| consumption and thus help the import skewed | | | | deficit at these levels in terms of significantly |
| trade deficit plus also help point toward a balanced | | | | affecting USD currency values.So it is quite |
| federal government budget! They want to see | | | | apparent here in my "World of Currencies," that |
| taxes raised, consumers spend less and a slower | | | | the structural strength of the US economy |
| growth rate in the US. It sounds like they want | | | | preempts 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 to | | | | supposed structural causes of the USD's decline, |
| short the USD until they can begin to see their | | | | its trade deficit, savings rate and government |
| remedies finding traction in the US economy. But | | | | deficit are non starters as targets for reform, |
| currency traders who buy into these prescriptions | | | | and more importantly, not structural weaknesses |
| will be on the wrong side of the USD trade in the | | | | after all. Forcing the American consumer to spend |
| long run. Dollar bears as they continue to sell | | | | less through higher taxes would wreck the US |
| dollars will have a long wait for any profits in | | | | economy 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, I | | | | US-centric international economic environment are |
| can tell you, neither the trade nor budget deficits | | | | real, 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 is | | | | international community of the sort the German |
| virtually impossible to see them doing anything | | | | model is resisting. The two points of view about |
| more than narrow marginally. The domestic | | | | where reforms must occur next are in fact, the |
| savings rate similarly is not going to rival the | | | | two sides of the USD trade.The market will |
| eurozone's 9% level, nor Japan's 6% for the | | | | declare the bottom for the USD as soon as it |
| foreseeable future. In fact, unless the American | | | | finishes making up its mind of how low that |
| shopper miraculously morphs into a parsimonious | | | | bottom should be, given its new recognition now |
| European or Japanese clone {something that is | | | | of the permanent status of a large US trade |
| not going to happen}, the annual American | | | | deficit.. 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.Quickly | | | | dollar, 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 | | | | |