Implications of the Ongoing Dollar Decline

Roger Nusbaum submits: Many of the financial apocalypse crew believe the U.S. dollar will crash for many of the reasons you probably already know, like the various deficits and so forth.

I've been in the "dollar going lower" camp for several years, and believe it will continue lower for the most part -- but that it won't be a wild cascade lower.

This chart shows the decline of the U.S. dollar over the last five years against the Canadian (in black), the British pound (the kind of salmon colored line), the Swissi (in blue) and the Norwegian (the kind of brown line).

The declines range from 20-30% over the five years studied, which is substantial. The question is how important is this. Clearly the American way of life has not been dramatically impacted by this decline, but an argument that says there has been some impact is probably valid.

My thought all along has been that this is a deterioration that will cause slightly higher interest rates, and have some effect on purchasing power along the lines of becoming a nuisance. The dollar is down what I would say is dramatically in the last five years, and the extent to which it has become a nuisance thus far for the general public is not that easy to see. Based on that, it is reasonable to wonder whether another 20% decline over the next five years will matter all that much.

One tangible effect thus far could be on the price of energy. Obviously the run up in oil over the last few years has had less impact on people living in countries whose currencies have gone up against the greenback, but in the U.S. we are spending an extra $20-$25 per tank, and more to heat our homes (depending on what you use). For the most part, this is a nuisance for most people, but this does hurt some portion of the population more than others.

In this light I think the probability of a truly calamitous event resulting from a dollar decline is low. Part of the equation is the extent to which the dollar is the world reserve currency. I have been saying for a couple of years that there is visibility, IMO, for the dollar to have to share this role, but even sharing the role the dollar is still very important not only for the global commerce conducted in the dollar, but also because so many countries sell us the stuff we need.

All of that said, nothing is impossible. In thinking about these things you need to sort out both probabilities and possibilities.

[Editor's note: We've tickerized this article with the PowerShares DB US Dollar Bearish Fund (UDN) given Roger's comment that "it is reasonable to wonder whether another 20% decline over the next five years will matter all that much". For a more complete list and discussion of currency ETFs, see Currency ETFs and ETNs.]

Comments

[Ralph F:]

This is a great article, Roger. Typical of your straightforward, common-sense approach which is so rare nowadays.

At some point significant declines in the dollar have to translate into higher import prices, and that means higher inflation. The main reason this hasn't happened until now is because the Chinese haven't let their currency float freely against the dollar. As a result, the yuan has been pulled into a devaluation with the US dollar, increasing the Chinese money supply and aggravating the overheating of the Chinese economy. Once the Chinese are forced to act, the yuan will rise against the dollar, raising import prices and inflation in the US. And that will force up interest rates.

The question is whether "that will cause slightly higher interest rates" as your write, or significantly higher interest rates as the Fed tries to fight stagflation.

Totally agree with your comments about the main impact being on lower income households via energy prices.

Add all this together, and it seems bad news for Wal-mart specifically, no?

2007 Jun 01 11:02 AM

[Chimin Sang:]

A dramatic fallout can be avoided if the US can sell more products to Asia. A slow devaluation or a bottom fall-off for US dollar is expected as long as the US trade deficit lasts.

2007 Jun 01 12:06 PM

[john gaats:]

Thanks for the good article. Some gold traders have been trying to over play dollor depreciation. I hope dollor could be on the road of recovery once Iraq war is ending satisfactorily. The war is a big drain as far as government spending is concerned.

2007 Jun 01 02:02 PM

[Roger Nusbaum:]

thanks for all the comments. China being integral really is <em>the</em&g... thing in that they could cause real problems. As it works directly against their interests I suspect they will not cause problems.

I would be surprised if pulling out of Iraq in any way shape or form would have a lasting impact on the dollar.

2007 Jun 01 10:44 PM

[wixeywaxy:]

Two observations: One, we have put the productive assets of the U.S. effectively on sale. Given enough time the assests acquired will be returning income to foreign owners instead of the current domestic ones. Given enough time it's going to effect the standard of living.
Second, the topic of Chinese currency valuation is presented to us as a reluctance of the chinese to respond to our government's urging. I think that is bogus (government always lies) The chinese are being allowed to exploit our markets and this can be changed. (Our Govt. allwoed first Japan, Taiwan, Indonesia, and Mexico to some extent before passing the baton for the major portion to China) Each of these exporters has accomodated us by recycling the dollars earned into our treasury debt allowing us to finance our expensive adventures. If you believe all this is happening in a purely market manner rather than being managed with very definite strings attached you gotta believe in the tooth fairy. What we are getting is not occuring by accident and there is a very definite long term leveling of the U.S. vis a vis the rest of the world being orchestrated. Vic

2007 Jun 02 11:08 AM

[irvinef:]

I am betting that the dollar to continue an orderly decline. Unlike Roger and other commentators, the DOLLAR DECLINE IS A GOOD THING. It makes U.S. exports more competitive. The reason the industrial sector is booming is because the dollar has returned to competitive levels. Caterpillar, Boeing, Harris Corp., and all our other industries are now selling to the Rest of World (ROW) aggressively. Its keeping GDP growth strong and the unemployment rates low...which especially benefits low income people. There is nothing like low unemployment to convince firms to give people without a great resume a chance.

If you go back, the dollar appreciated 20% in the late nineties because foreign investors, wanting to invest in our stock market boom, bought dollars first and bid up the dollar. This made U.S. exports too expensive and U.S. producers started outsourcing to survive. Manufacturing employment peaked in 1998 when the dollar made exports too expensive.

Fortunately, this time around, the ROW is booming, foreign stock markets are rising faster than ours, so the dollar is drifting lower, helping our exports, job growth, profits, and in turn the U.S. stock market.

An orderly dollar decline is good for the USA.

What could kill this situation, protectionist moves by Congress. We are in a global boom that is benefiting us. Do not let misguided politicians mess it up. Support free trade.

Owen Irvine

2007 Jun 02 12:51 PM