Weak Dollar, Weak United States?

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by: John M. Mason
Summary

Over the past year, the value of the US dollar in world markets has declined significantly, and expectations are for it to fall further.

From the US side, President Trump has wanted the dollar to get weaker, while economies throughout the world have shown a major increase in growth rates.

Whereas the weaker dollar may help US growth in the short-run, in the longer-run, history has shown that the benefits can be sustained only through further declines in value.

What a difference a year makes.

About one year ago, it took just under $1.04 to purchase one euro. It took about $1.22 to purchase one British pound. Today, it takes over $1.19 to buy a euro and over $1.35 to purchase a pound.

President Donald Trump wanted a weaker dollar. Well, he has gotten what he wanted.

And, there has been some short-term benefit to him getting what he wanted. The weaker dollar contributed to a narrowing of the US trade deficit in the second and third quarters of 2017, and this helped to raise economic growth.

In the third quarter of 2017, the year-over-year growth rate of real GDP was revised upwards to 2.3 percent. Earlier in the year, the year-over-year growth rate was around 2.0 percent.

But what does it mean to have a weak currency over the longer-run?

I believe, along with former Fed chairman Paul Volcker, that “a nation’s exchange rate is the single most important price in its economy.” [1]

Since Mr. Trump was elected president, some risk-averse foreign money has apparently been leaving the United States. I have written about this frequently.

Although there is not a specific series of data from either the Federal Reserve System or from the International Monetary Fund that defines this flow, variations in money flows connected with changes in relative international interest rates, movements in foreign exchange rates, and statements by policy makers, traders, and analysts present a consistent story of the flows that are taking place.

For example, in the 2012-2013 period, a period in which Europe and other parts of the world were having significant financial difficulties, lots of money was flowing into 'safe havens' like the United States, Germany, and Switzerland. During this time period, there was a dramatic drop in the yields on US Treasury Inflation Protected Securities (OTC:TIPS) that took yields on the 5-year issue and the 10-year issue significantly below zero.

Only as this flow lessened in the 2014-2016 period did these yields move back into positive territory. Just before Mr. Trump was elected, the yield on the 10-year TIPS was just above zero around 0.07 percent.

Today, that yield can be found in the 0.50 percent to 0.60 percent range.

From the information I can gather at this time, a significant amount of the risk-averse monies that had flowed into the United States seeking a “safe haven” in the 2012-2013 period and that had remained in the United States up until the surprise election of Mr. Trump, now reversed direction. These funds started flowing out of the US immediately after the election resulting in the rise in the yield on TIPS and other US government securities.

This put pressure on the value of the dollar to decline, but the major part of the dollar's descent came after Mr. Trump began to “talk down” the value of the dollar after his inauguration.

The strength declined against other currencies as well. The Wall Street Journal index of the US dollar was well over 103.00 in the middle of December 2016. The index dropped to 92.90 last Friday.

One year ago, there had been talks about the parity between the dollar and the euro. Now, the talk is for the euro to continue to rise on the basis of the strength of the eurozone economies and analysts are looking at the price rising above $1.20, possibly even up to $1.25, even with the problems Ms. Merkel is having forming a government in Germany.

The thing is that a decline in the value of a currency can help an economy in the short-run as foreign exchange rates change. However, history shows that the short-run gains in a narrowing trade deficit do not last and that, in the longer-run, a weak currency does not really produce the incentives for companies to increase productivity and innovation, increases that are needed to stay competitive in the modern world.

Trade barriers and other trade protections also do not help raise company competitiveness.

And, as I have written about often, part of the current American growth problem is that the growth of labor productivity is already quite low. The weakness in the value of the US dollar will not help to solve this problem.

Furthermore, a strong stock market based upon the support of the Federal Reserve System will not contribute to further economic growth, even with tax reform legislation that is supposed to help corporate profits.

Corporations know what is going on in the world with the weak dollar and the current Federal Reserve policy and will only continue to use tax benefits and low interest rates to buy back more stock and to pay out more dividends.

Financialization continues to rule the corporate world and will continue to do so until the federal government stops producing more and more rounds of federal deficits and more and more rounds of credit inflation.

Businesses and investors need to watch where the value of the dollar is going. Currently, I believe that it is telling us a lot about the economic policies of the present Republican administration and its Republican Congress. Unfortunately, it is now indicating weakness rather than strength.

Notes:

(1) This quote can be found on page 232 of the book Mr. Volcker wrote with former Japanese vice-minister for international finance, Toyoo Gyohten titled “Changing Fortunes: The World’s Money and the Threat to American Leadership.”

Disclosure: I/we 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.