Is U.S. Dollar Weakness a Recession Indicator?

As goes the dollar, so goes the economy. Perhaps. The next FOMC meeting is March 20 and 21. It is almost a forgone conclusion that the Fed will cut rates, perhaps aggressively. Meanwhile, the dollar is weak, and another rate cut will likely weaken it further. It currently takes $1.01 to buy one Canadian dollar (called the loonie) and that is the wholesale rate. At a retail currency exchange you will pay about $1.09. In 2002, it cost only about $0.65 to buy one loonie.

So when in the past did the loonie exceed parity with the dollar? I'll give you some hints. The Everly Brothers had a big hit with "Bye Bye Love." Cadillac came out with a new model that had gigantic tail fins, below.

So why am I bringing this up? Some people seem unsure that the country is yet in a recession. But besides 2007-2008, the only other times the loonie exceeded parity with the dollar were 1957-1960 and 1971-74. Both of these periods were marked by deep recessions in the US. In the late 50's there was a deficit, coupled with rising consumer prices and unemployment. In 1971-74, the country experienced stagflation, a non-growing economy coupled with rapid price increases.

So it seems that a weak dollar might be an indicator of a recession. And with the Fed likely to continue cutting rates, what does this mean for the currency near term? I believe the immediate, short-term effect, will be higher stock prices and a lower dollar. Foreign stocks would be likely to increase the most, given devaluation, and while it will seem with each rate cut that stockholders are wealthier, in global terms, they are really no better off; they merely have more units of measurement (dollars).

I suspect that by the end of the year, it may take more than $1.60 to buy one euro, unless the ECB cuts rates. This is, of course, just speculation. The Swiss franc, however, is at its highest level ever against the US dollar; it currently takes $0.98 to buy one Swiss franc.

As for the dollar itself, I believe that when you hold a currency, you are holding de facto shares in the "corporation that is that country." If the dollar continues to devalue against the euro and the loonie, it will be not only because of the rate cuts, but also because the risk of holding it increases when more of the federal deficit is financed through debt. In 2006, the US current account deficit was 6.5% of GDP and the final tally is not in for 2007. It is my opinion that the bottom-line issue for the US and its economy is debt, both public and private. And with budget shortfalls to finance, it would seem that interest rates really need to increase to bring foreign investors to the table. Lowering rates only decreases demand for the dollar and its value, lowering returns to foreigners.

When the euro was launched in January 1999, the price of one euro cost $1.17 to buy; today it is $1.53 and some countries now prefer to hold reserves in euros. Why the appreciation? Other than the recession, one reason could be the EU’s Stability and Growth Pact. This limits its members’ current account deficits to 3% of GDP and long-term debt to no more than 60% of GDP. These fiscal limitations may prevent governments from extra capital spending to stimulate their economy at times, but they do promote a sound currency.

In the long term, I believe that is the better policy, and for now I would rather hold shares in the corporation that is the euro. Perhaps a similar fiscal policy would be appropriate in the US.

Comments

[CarlosSlim]

The average Red State American has a high school education, is obsese and shops at Wal-Mart. Since only 20% of Americans have passports, the average American does not travel to Mexico, much less Europe.

How does the falling dollar affect the Average American?

Until prices skyrocket at Wally World, how does the Average American know what to think about the falling Greenback?

[low]

Do you hear that drum beat special1? It's the remaining 3/4s of the world economy trying to size us up for our coffins without admitting it. It's the sound of a dragon licking his chops delirious at the thought of how unlikely it is that anyone will be grabbing him by the tail. And a butcher sharpening his cleaver in preparation to divy up the remains of those who dare try!

It's reverse subversion. $5.00 an hour welders who are not important enough to their employers to provide them with hardhats or steeltoe boots. Asian collection agents who don't know you from Adam but
specialize in why you missed your mortgage payment.

Now as far as fiscal policy goes, we'd all have to be prepared to wrestle that bugger down. What is the national debt now anyway? Aside from the question of employment, I understand theres a grand "plan to rescue the credit market". Print more money but don't
mind more gold. And heaven forbide some moron suggest a return to the gold standard. Lets see, do you think 5,000 tonnes would equal $45 trillion? Thats
another reason their in no rush to bury USD, the same
reason we won't return to the gold standard and the same reason their just barely able to control the price
of it.

By the time prices skyrocket at Wally Mart, it might be well past too late to matter.