The Dollar Approaches Critical Levels

The dollar continues to trade lower, and is now only a few percentage points above its all-time lows against other currencies, both nominally and in inflation-adjusted terms, as shown in these two charts above.

Bernanke's speech Monday provided no comfort for dollar bulls, since once again he all but guaranteed that monetary policy would extraordinarily accommodative for a long time, while also remaining relatively downbeat on the prospects for the U.S. economy. He promised the dollar would remain a strong currency, however, and he noted that the Fed was watching the dollar's value, but he utterly failed to say how the dollar might rise from all-time lows to a level that might be considered strong. He also failed to comment on the significance of gold reaching another all-time high of $1140/oz., and what that says about the dollar's value and the Fed's stewardship of the currency.

A dispassionate observer would undoubtedly conclude from all this that the fundamentals couldn't be much worse for the dollar than they are today: weak economic growth prospects, astoundingly profligate fiscal policy, massively accommodative monetary policy, and an almost total absence of any official concern for the value of the dollar. But the same observer would also note that the dollar's value today is largely consistent with these fundamentals.

So where does that leave us? When the fundamentals are awful and the pricing is awful, then awful things must happen, otherwise the market is going to have to rethink its position. I think that as the dollar approaches its all-time lows the situation is increasingly ripe for some big shocks to consensus thinking. Perhaps the economy isn't as weak as everyone seems to think. Perhaps the Fed won't have to keep short-term rates at zero for another year.

Meanwhile, dollar weakness continues to go hand in hand with equity market strength, as this chart, which I have been showing repeatedly, shows. My theory for why a weak dollar is good for the stock market is that the dollar's weakness is a reflection of a rebound in money velocity, and that in turn is fueling an expansion of economic activity worldwide. There is at least one silver lining to the dollar's otherwise miserable condition.

Comments

[Alex Bernstein:]

Bernaky will allow dollar to decline steadily pretending that it make sense for US to have strong dollar. There are not many good reasons for a strong dollar now. By having week dollar we artificially increase sale to the rest of the world, which creates increase in US employment. Also, relative worth of US employees compensations decrease with week dollar. This creates reduction of relative American standard of living. Therefore, any highly qualification labor intensive goods will be much more competitive than US competitors efforts. High tech, heavy machinery, and basic commodities companies have to benefit from current administration, and Federal Reserve policies.

Nov 16 05:18 PM

[bob adamson:]

One plausible scenario from the analysis set out in this article is that the US dollar will continue to depreciate, but slowly, into 2010, and then recover somewhat around February/March.. The back-story here is that future trends in the global and US economies and in the stock and commodities markets lack conviction at present and that people are both edgy and uncertain whether to be optimistic or pessimistic. A case can therefore be made that current trends will drift along current trajectories in the short term but are subject to change in the near future. These changes need not be dramatic, however, unless some unexpected event or situation arises.

Nov 16 05:32 PM

[herbert hoover:]

Does Bernanke win approval for his second term if he continues the dollar freefall? That determines what happens next.

Nov 16 05:54 PM

[ilc:]

"My theory for why a weak dollar is good for the stock market is that the dollar's weakness is a reflection of a rebound in money velocity, and that in turn is fueling an expansion of economic activity worldwide."

I have a different theory: 0% interest rates effectively punish people if they hold cash, giving them little choice but to invest in assets, commodities, etc. And that is part of the Fed's intent. (Not to push people into gold or commodities; but to push them into stocks, real estate and higher-yielding bonds, for sure.)

Also, a weak dollar makes U.S. equities look less expensive to foreigners.

Nov 16 06:05 PM

[Gedankonomist:]

It has been said that the "weak" dollar benefits trade for the US.

Yes, in the same way a "weak" currency "benefits" a third-world country.

So the FED-inspired logic is, "let's print more money, let's close the trade gap" never mind the fact that we are turning into a banana democracy.

Nov 17 10:04 AM