The United States Dollar In Early 2014: Short-Term And Longer-Term Outlook

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 |  Includes: CNY, CYB, FXE, UDN, UUP
by: John M. Mason

Over the longer-term I still believe that the value of the United States dollar will fall against most currencies, especially those in the developed world. In the short-term, however, the picture is mixed. And, to get a clearer picture, I think you at least need to divide the analysis into three compartments: the euro; developed nations; and emerging countries.

Over the longer-term, the situation is not that much different from the situation that has existed for the past fifty years or so, with the exception that China will be a major player going forward. Until the middle 1990s, China, on the economic front, has been a relatively minor player.

The first point here is that the United States has not only put itself in a precarious situation but it has learned little or nothing about the conduct of economic policy over the past fifty years.

The first comment relates to where the federal government has taken the United States over the past five years. With three bouts of quantitative easing on the part of the Federal Reserve and the still relatively large deficits in the federal budget, the United States faces real inflationary problems when the economy begins to use the liquidity that has already been put into their hands.

In terms of the second comment, I do not believe that the federal government will revert to a more prudent management of its budget in the future and the Federal Reserve will have to support this fact with a monetary policy that I would refer to as relatively easy. The alternative would be to allow interest rates to increase rather dramatically and unemployment to rise to unacceptable levels. The latter, I believe, would not be acceptable.

The second point in the longer-term view is that China will be an important factor in the world in the upcoming years. The United States will be facing a China that is very disciplined when it comes to competing in world currency markets. If the United States fails to take this into account when developing its economic policies, I believe that Chinese currency will "run over" the American dollar. I have stated in the previous two paragraphs that I don't believe that the United States will start out the period with this discipline. It will be interesting to see just how long it takes the government to realize the situation and to convince Americans to pay the price to be competitive in foreign currency markets.

In addition to this, I believe that a German-led European Union will be fiscally conservative and that this will mean that the value of the United States dollar will continue to fall relative to the euro. Thus, if the United States does not become much more fiscally and monetarily conservative over the next ten years, then it will be competing at an extreme disadvantage to two of the most important trading blocks in the world.

Longer-term … I expect that the value of the United States dollar will be down. In the shorter-run, the movement in the value of the dollar will be mixed and depend a little more on the specific, current problems being face throughout the world.

In terms of the euro, over the past two years or so, the Euro has strengthened against the United States dollar. During this time, the exchange rate has gone from about $1.20/euro to approximately $1.37/euro.

The reason for this, I believe, is that the European Union finally began to pull itself together economically and this has resulted in a reversal of money flows, benefiting the value of the Euro. As mentioned above, I believe that the influence of Germany over other EU nations finally began to kick in over the past several years and this has meant a more conservative approach to economic policy. As this finally was seen as becoming a reality, risk averse monies that had left the European continent during the fiscal and monetary crisis that had occurred began to return to European financial markets. Investors sold dollars and bought Euros.

This continued up until the last month or so as the Federal Reserve actually began to taper its purchases of securities in January 2014 and, in the face of growing discussion about deflation in European circles prompted a statement from Mario Draghi, the president of the European Central Bank, in which Draghi signaled his concern over the fact that inflation was running lower than the ECB desires and that the ECB will stand willing to purchase bank loans and other debt instruments to fight to possibility of European deflation.

Thus, you had Draghi's discussion about ECB easing and you had the Federal Reserve actually cutting back on its monthly purchases of securities and this worked in the favor of raising the value of the United States dollar against the euro … in the short-run.

This, however, is not expected to continue over the longer-run, as described above.

Relative to other major currencies, I believe that the in the short-run, the value of the dollar may continue to rise. This has been the case over the past three years if you look at the Federal Reserve's "Trade Weighted U. S. Dollar Index against major currencies." I think that relative to most of the currencies in this index, the growth in the United States economy has tended to be relatively weak when compared with many of these "major" nations.

This may just be a relative run over this three-year period because over the past 15 years or so, the value of the United States dollar has declined substantially relative to these currencies. Although in the shorter-run this US dollar strength may continue, I expect this downward trend will continue over the longer-run.

Finally, it is time to say something about the currencies of the emerging markets. Over the past four years, the US dollar index that traces how these currencies have performed relative to the dollar remained relatively flat. That is the index four years ago is about where the index is currently.

Here you have a many countries that really pushed themselves economically for a time, attracted foreign monies, and then expanded their fiscal affairs by too much and now they are facing substantial currency depreciation against the US dollar. There are the mis-managers. You have other countries that issued too much debt. These have a debt overload. And then you have the countries that face economic dislocations because they have run large current account deficits and have had to finance these deficits externally to the country.

In recent times, as the Federal Reserve has begun to taper its security purchases, these emerging nations have faced a withdrawal of money from their markets and a relatively drastic fall in their currencies. The US dollar will remain strong against these currencies in the short-run.

The question is, what will happen over the longer-run? The whole outlook depends upon whether or not these countries can establish fiscal control over their budgets and constrain their central banks. This is not quite the model they have laid out for their countries and many of these nations tend to lean toward a more "progressive" approach to their social programs. Yet, some of these countries are going to get their "acts" in order and, given what I have assumed to be the future of United States economic policy, I would expect the currencies of these countries to do quite well against the dollar.

Overall, I would argue that the value of the dollar against an index of these countries would be flat over the longer-run.

In conclusion I would say that, in general, the United States dollar may be relatively strong in the shorter-run … but, over the longer-term … the value of the United States dollar will be down against most currencies.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.