Why a Weaker Dollar Is Good for Stocks

Here's an update on this very important and intriguing issue. Normally, I would say that a weaker dollar is a bad thing (since from a supply-side standpoint a stronger currency is always preferable to a weaker currency, since a strong currency inspires confidence and confidence generally leads to more investment), but as the second chart shows, for the past several months equities have been rising significantly even as the dollar declines.

I've argued before that one way to explain this is to realize that the dollar's value has been driven primarily by the world's demand for dollars as a safe haven. That is illustrated in the first chart, which compares the dollar's value relative to other major currencies to the growth of US currency outstanding. In the past year this relationship has been more pronounced than at any other time I'm aware of: dollar strength has occurred during a period of major accumulation of US currency, most of which is held overseas.

On the margin, demand for dollars has dropped. With currency growth now almost back to zero, the dollar is declining, and equities are rising. This means that confidence is rising on the margin, and the next shoe to drop will be rising spending and perhaps a decumulation of dollars. Of course, rising spending is not really what drives an economy to new high levels; for that you need investment spending. So far, I don't see signs of a big increase in investment spending, which is one reason I've been saying that this will be a sub-par recovery.

Comments

[chap08]

I disagree with your view that a weaker dollar would normally be a bad thing for stocks. It is difficult to separate out the different affects, particularly with the dollar due to its safe haven and reserve currency status, but:

1. Clearly a lower dollar means more competitive exports and less competitive imports, boosting the domestic economy. Countries that have really suffered recently are those that have been unable to devalue their currency sufficiently (e.g. Ireland). Their stock markets have fallen further.
2. Foreign earnings become ever more important for US companies. Demand in the US will be dead for years. The growth markets of tomorrow are overseas. A weaker dollar translates these earnings in to higher EPS.
3. Yes, a stronger dollar used to be associated with confidence, but this is much less the case now. When the Fed was fighting inflation, a weak dollar implied higher inflation and interest rate rises. Now that the Fed is fighting defaltion, a weak dollar helps.

2009 Aug 04 06:53 AM

[Michael Clark]

So, for Americans, with stocks rising, and the dollar dropping, does that mean it's break-even at best. More dollars from stocks -- but the dollars worth less with the dollar's depreciation?

Is it really good for Americans to have a declining dollar?

2009 Aug 04 06:55 AM

[CautiousInvestor]

I think it has more to do with the reflation thesis under which a limited measure of inflation is good for stocks because of pricing power and earnings.

As of late, there is a strong and persistent inverse relationship between the dollar and the price of commodities; and there is an inverse relationship between the dollar and equities. When the dollar is down both equities and commodites are up.

2009 Aug 04 08:53 AM

[dataman2]

everyone is correct. Seldom does only one variable explain correlations.

2009 Aug 04 09:18 AM

[dataman2]

Great discussion.

Everone is correct as many variables usually explain correlations.
Personally, the fear one seems to have the most explanations.

2009 Aug 04 09:22 AM

[retired aviator]

<<Normally, I would say that a weaker dollar is a bad thing (since from a supply-side standpoint a stronger currency is always preferable to a weaker currency, ...>>


I think many Japanese businesses would strongly disagree with you. It is generally thought there that the strong yen has kept the Japanese economy depressed for years since they rely greatly on exports.
----------------------...

Comment on Michael Clark's question a few posts above: A "weaker dollar" usually refers to its relationship with other currencies. That is a distinctly separate thing from its domestic purchasing power (inflationary debasement). So prices in the U.S. can stay pretty stable during a period when the dollar's value on FOREX swings wildly. In fact we saw this in the past year when the dollar rose quickly a whopping 25% or so against other currencies during panic deleveraging, and has since retreated by over 10%. These FOREX moves don't translate into swings in what you pay to go to the movies, or rental apartment rates, though eventually they influence prices of some things. Inflation (consumer prices) and the dollar's value on FOREX are very weakly correlated, especially in the short term.

2009 Aug 04 12:06 PM

[Mad Hedge Fund Trader]

It certainly makes them cheaper for foreigners. The chickens are finally coming home to roost for the dollar, which has gapped since Thursday from $1.40 down to $1.4450 against the euro, and done even worse again the Australian, Canadian, and New Zealand currencies. Crude traders tell me that the weak buck is making oil go up, while currency traders inform me that it is strong crude that is causing the dollar collapse. It’s like an Agatha Christie murder mystery where all of the suspects are guilty. If we are on the eve of an economic recovery, many fear that the US will return to its old, evil, high consuming, high importing ways, and that the trade deficit will skyrocket. If is doesn’t, then you can count on burgeoning government borrowing to knock the stuffing out of the greenback. It sounds like a heads I will, tails you lose bet. This is not exactly a new trend. The chart below shows the purchasing power of the dollar since the Revolutionary War, and it has been mostly downhill since 1929. No, I have not been trading the market that long. Better to take your pay in Euros, American double Eagle gold coins, bushels of wheat, or barrels of crude.

2009 Aug 04 12:08 PM

[Tom E.]

A weak dollar also makes it less attractive for Europeans and others to buy US stocks, so that makes for less buying pressure.

2009 Aug 04 12:48 PM

[Michael Clark]

Thanks for your response, RA. My concern is less with the everyday swings on the FOREX and more with the debasement of the currency over a longer period of lower and lower rates. I realize that a weaker dollar can help us sell exports and grow jobs -- again, my concern is that a weaker dollar is weakening our foundation as a nation. Why has our savings rate gone to nothing, until recently. Who wants to be holding the dollar when the banks and the Fed are trying to make the dollar worthless?


On Aug 04 12:06 PM retired aviator wrote:

> <<Normally, I would say that a weaker dollar is a bad thing (since
> from a supply-side standpoint a stronger currency is always preferable
> to a weaker currency, ...>>
>
>
> I think many Japanese businesses would strongly disagree with you.
> It is generally thought there that the strong yen has kept the Japanese
> economy depressed for years since they rely greatly on exports.<br/>---...
>
>
> Comment on Michael Clark's question a few posts above: A "weaker
> dollar" usually refers to its relationship with other currencies.
> That is a distinctly separate thing from its domestic purchasing
> power (inflationary debasement). So prices in the U.S. can stay
> pretty stable during a period when the dollar's value on FOREX swings
> wildly. In fact we saw this in the past year when the dollar rose
> quickly a whopping 25% or so against other currencies during panic
> deleveraging, and has since retreated by over 10%. These FOREX moves
> don't translate into swings in what you pay to go to the movies,
> or rental apartment rates, though eventually they influence prices
> of some things. Inflation (consumer prices) and the dollar's value
> on FOREX are very weakly correlated, especially in the short term.

2009 Aug 04 01:16 PM

[j-dub]

Thoughts on Cetin

How many ID's, like the one above, does this weed have? It's like the Matrix where they keep multipying but you need to kill the right one.
Seeking Alpha-can't we get rid of Cetin and his multiple ID's?


Cetin=the weed spammer from hell

2009 Aug 04 10:07 PM