Dollar Update: A Contrarian View

Here are two versions of the dollar's value against other currencies. The first compares the dollar in nominal terms to a trade-weighted basket of major currencies (Euro, Yen, Pound, Canadian dollar, Swedish Krona, and Swiss franc), while the second compares the dollar in inflation-adjusted terms to a very large trade-weighted basket of almost all currencies.

By either measure, the dollar is very weak and looks to be trending lower. The dollar is weighed down by extremely accommodative monetary policy, by profligate fiscal policy, by the specter of increasing regulatory burdens, by high unemployment and weak economic growth, and by the prospect of trillion-dollar deficits for as far as the eye can see.

Everyone knows this, though—it's all on the front pages every day—and that arouses my contrarian instincts. With the dollar's value against other currencies and against gold near the bottom of historical ranges, it is undeniably cheap. It could get cheaper still (and I'm reminded here of Art Laffer's admonition that fiat currencies have no intrinsic value and can therefore be in perpetual decline), but selling the dollar at this point implies considerable risk.

When tons of bad news is hitting the tape everyday, and the value of the asset in question has fallen to historical lows, to be bearish on the asset requires a firm conviction that things are going to go from very bad to really, really bad. For the dollar to rise you don't need to see good news, you just need to see news that is not awful. Mere bad news might suffice to keep the dollar from falling further. Modestly good news, such as an early move by the Fed to raise interest rates even by a little bit, or news which shows the economy is likely to simply avoid a double-dip recession, or news which indicates just the tiniest rightward shift in fiscal policy, might be enough to push the dollar higher.

It's hard to fight the tape on this, but I continue to believe that the long-run prospects for the dollar are favorable. I think the economy is doing better than most give it credit for, I think the Fed is going to move sooner than most expect, and I think that policies in Washington are going to turn out to be less awful than the market fears. I'm not saying that everything is going to turn rosy, merely that I don't see things getting worse forever.

Comments

[Scared Stiff:]

I'm not saying you're wrong... but I'm curious to know why you think all those things you listed in the last paragraph, other than that it's the contrarian view. "Just doing the opposite of the obvious" seems like a good way to get hit by a car, or drowning in your bathtub.

Oct 12 04:48 PM

[Thomas MacLeod:]

Your views are very respected but what if more dollars are being printed to hold up treasuries? I don't know if this is true but looking at the market one does get a feeling that is the case. We are not talking about gold where the supply is limited we are talking pcs of paper where the supply is infinite!

Oct 12 05:22 PM

[Charlie J:]

Calafia said, "I think the economy is doing better than most give it credit for, I think the Fed is going to move sooner than most expect, and I think that policies in Washington are going to turn out to be less awful than the market fears."

I have to respectfully disagree. I wish these were true, but I don't see any evidence to back them up, and I'm constantly seeing evidence to the contrary. Re the economy getting better: I suggest reading Dave Rosenberg, who tells it like it is. Re the Fed moving sooner: politically, they will not be willing to raise interest rates. Re Washington: Are you kidding me? Read Karl Denninger who has pretty good details about that.

Oct 12 07:43 PM

[J. Bruun:]

It is easy to agree that the dollar should be weak on its own and perhaps even increasingly so. However FX is about relative strength. So the question is are things developing better or worse in US compared to e.g. JP, EU and GB? That is by no means a clear cut yes to me. On a valuation perspective I also think it by no means clear cut that the USD i expensive. Google anything you like such as hotel rooms, restaurants, gasoline in Europe and that will provide some perspective.

One scenario put forward (I don't remember where) is that stronger dollar drivers equities and commodities down which in turn drives risk appetite down which then leads to a flight to USD and all of a sudden USD is much higher.

Further to the authors credit some of the current news is just a little on its head when it comes to normal argumentation. Take this one I saw today: European equity markets up on weaker USD...

Oct 13 11:57 AM

[tripleblack:]

"It's hard to fight the tape on this, but I continue to believe that the long-run prospects for the dollar are favorable. I think the economy is doing better than most give it credit for, I think the Fed is going to move sooner than most expect, and I think that policies in Washington are going to turn out to be less awful than the market fears. I'm not saying that everything is going to turn rosy, merely that I don't see things getting worse forever."

I would agree that the economy MIGHT be doing better than many bears are seeing right now - there's a reactionary tendency to see things in the worst possible light... I agree, Bernanke is going to shock some folks this winter, and the fireworks are going to be interesting, though we should not forget the unionist now running the roost in the New York office... As for the policies, I disagree, they are going to turn out WORSE (long term) than most folks think, but then again, we DO have elections every few years where we can vote for "change", and that's a road that runs both ways.

Oct 14 07:19 AM