Marc Chandler Dissects the Dollar's Decline, Part I

Mike Norman, anchor, HardAssetInvestor.com (Norman): Hi everyone and welcome to HardAssetsInvestor.com's interview series. I'm Mike Norman, your host. Today we're going to be talking about the dollar, which has been in a six-year downtrend now. My guest is Marc Chandler, chief currency strategist for Brown Brothers Harriman. Marc, thanks a lot for being here; I really appreciate it.

Marc Chandler, chief currency strategist for Brown Brothers Harriman (Chandler): It's a privilege.

Norman: Let's talk first about the big picture. As I mentioned, the dollar has been in a downtrend for the last six years against a narrow basket of currencies like currencies in the euro zone, Japan, Canada down about 40%, down a little bit less against a broader basket of currencies. First, tell us what you think of the driving forces behind it and where are we in this move. Are we closer to an end or is it still going to go?

Chandler: I think that's a very important question because as you say, the dollar has been falling, but what's been pushing it down? Some people will tell us that the dollar is declining because the "end-of-the-U.S., we're being squeezed, overstretched empire" sort of theory. Some people say, well, the central banks around the world are diversifying reserves.

We tend to think that oftentimes the market exaggerates structural influences and doesn't fully pay enough due to cyclical forces. We think the dollar's decline is largely cyclical, having to do with the Federal Reserve stopping raising rates before other countries, cutting rates before other countries, continuing to cut rates aggressively before other countries like the ECB cutting rates. So we think that the dollar's decline is fundamentally driven by these cyclical factors, and the good news is that the cyclical factors are just about over.

As we know, from the end of April, the Federal Reserve has stopped cutting interest rates. As soon as the Federal Reserve signaled, or the markets thought they were signaling, positive interest rates, the dollar bounces back. It bounces back a nickel against the euro.

Already I'd say that in the G7 group, there are five currencies. If you exclude the dollar, there are four currencies: the dollar bottoming against two of them, the Canadian dollar and the British pound, last November. So we think that the dollar's multiyear decline - like you pointed out, steep decline - that we're at the tail end of it.

The dollar is already bottoming against some currencies; not only the sterling and Canadian dollar, but against some emerging market currencies. What we're looking at in the coming months is for the dollar's base to broaden out, for the dollar to have a better recovery going forward.

Norman: What about the argument that some dollar bearers have that, you know, it's our trade deficit and our current account deficit? Which actually if you look at those things over the last two years, they've been improving the deficits there.

Chandler: A lot of us took Econ 101 and were told from our professors that a country with a large trade deficit should have a weak currency. But when you look at the currencies that have been very strong, like the Australian dollar, they have a bigger trade deficit as a percent of GDP than the U.S. does.

The U.S. government reports data almost every day. The one that's the least understood is the trade balance. For example, half of our trade deficit can be accounted for by the shipment of goods within the same company, say a company like GM breaking a system up in Ontario, Canada, and exporting it back to GM in Detroit. The government tells me that's a trade deficit. I say that's a movement of goods within the same factory. It's a virtual factory. That's what globalization means. You've got a virtual factory, and the movement of goods from one side of that factory to the other side of the factory crosses these manmade boundaries, the 49th parallel; it's not a trade deficit.

So I think that we misunderstand our trade deficit. A lot of the trade deficit can be explained away in terms of not having the capital flows as a payment for them. I think that we'll see the U.S. dollar recover before we see a significant improvement in the U.S. current account imbalance from current levels.

Norman: Now some people say the dollar's decline is contributing to inflation. How much of an impact, I know on import prices, but really how much in terms of the economic impact here in the United States does the dollar have?

Chandler: That's important because one of the consequences of the falling dollar, a couple ways that people think about it, one is that it reduces the demand for U.S. assets or makes interest rates high, but we know that U.S. assets have outperformed others in the last several months. The inflation angle is another channel in which a weak currency could impact macroeconomics. What happened is when companies compete in the U.S., they typically are not raising their prices more than domestic producers, excluding of course the price of oil. So what we're seeing is, at least in the U.S.' case, inflation can be explained by other factors besides the weak dollar. I think for other countries it's more important. The weak dollar is a factor that might be on the margins, pushing up some food prices, some energy prices might be going up because of a weak dollar. But look what happened recently when the dollar bounced against the major currencies, 5% against the euro or so: Oil prices still moved higher. I'd say that ironically the relationship between oil is not very consistent or stable with the currency markets. My guess would be inflation is going to ease before we see a major change in the FX market.

Norman: All right, there you have it. Inflation will ease before we see a major change in the FX markets. Stay tuned for more of our interview series. For now, this is Mike Norman. We'll see you right here.

Be sure to check Part II of the interview with Marc Chandler next week.

Comments

[fxtrader07:]

funny take on the trade deficit, really. you know, it makes zero difference whether the deficit occurs within one u.s. company or between a sovereign foreign company and a u.s. importer. a s a result, in both cases more dollars flow out into the world than are spend via buying goods and services in the u.s.
that strange way of "explaining away" half of the trade deficit alone is sufficient to tell me that Mr Chandler has no clue about currencies markets, trade balance and current account relationships.
I for my part, do not need a second part. i am already done with this "expert"

2008 Jun 05 04:37 AM