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Monday January 17, 2005 - 10:58:21 GMT
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A case for the dollar


“Something will give. For once, I'm afraid, everything will drop. The only asset that is undervalued is the U.S. dollar. In the long term it is a doomed currency, but now it has a good chance to appreciate. If the dollar is strong, as I expect, GDP growth will be disappointing because a strong dollar means tighter monetary conditions. The consensus is far too optimistic about the U.S. economy and about growth in China.”

Marc Faber, Quoted in Barron’s Roundtable 17 Jan 05

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Morgan Stanley economist Stephen Roach, a man on a mission to rid the world of “global imbalances,” recently wrote, because of the “sharply diminished size of America’s industrial base makes it exceedingly difficult for the US to turn dollar depreciation into an advantage and trade its way out of a severe current-account problem through enhanced export growth and import substitution.” But a depreciating currency is the primary tool that he and others are advocating as the single best way to reduce the current account deficit.

According to Mr. Roach, “imports are 52% larger than exports, making it mathematically impossible for the US to export its way out of its trade deficit.” Gulp!

Are you as confused as I am now?

Mr. Roach, and many other “prominent” economists, say currencies are simply relative prices. Let’s accept that for now. And their policy description for “global rebalancing” is based on pushing down the dollar. Yet, we know pushing down the dollar means the relative costs of imports rises i.e. the value of imports in dollars rises. And, because imports are half again larger than exports, AND the US economic base is primarily services and value-added manufacturing, it seems a falling dollar will only exacerbate the current account bogey man.

Based on this evidence, shouldn’t policymakers be doing everything they can to INCREASE the value of the dollar? It would reduce import costs. And if a growing component of our value added manufacturing is sourced internationally (imported components), companies could stay competitive despite the value of the dollar increasing i.e. relatively lower costs of goods provides more flexibility in pricing.

I am once again missing something? Probably! Does 2+2=5? Maybe!

I respect the fact that Mr. Roach admits there might be a little wrinkle in the “amazing shrinking dollar path to prosperity” economic policy. And what is it that might be a real tool in helping to reduce the US current account deficit? Higher real interest rates!

Rising rates will reduce US consumers import appetite, according to Mr. Roach. How? US consumers will need to save more money to pay off their rising debt burden because they won’t be squeezing much wealth from their individual asset bubbles in a rising rate environment. Thus, instead of shopping 24/7, US consumers may spend some of that time at the bank making savings deposits.

Result: The volume of imports declines and the pool of savings to fund the Double-D’s of Doom (Twin Deficits) can be more easily sourced domestically.

Ah, but here are the questions that the dollar doom and gloom crowd may want to reflect upon.

We already know that rising real rates make the dollar relatively more attractive. But, if a greater portion of the deficits can be funded domestically, because of RISING RATES, doesn’t that alleviate one of the main criticisms i.e. the US dollar is risky because the US is so highly dependent of “foreigners” to fund the deficits?

And if that doom and gloom is lifted from the dollar’s back, might is not be able to straighten up and walk taller?

And if the buck rises, won’t that help reduce the cost of imports more, at the same time US consumers are saving more?

Could we possibly see a virtuous circle of a rising dollar and a falling current account deficit? And if so, wouldn’t this circle be self-reinforcing? It would be quite a surprise! And as we know, surprise is the mother’s milk to rapidly changing asset prices. Even a hint of such a scenario emerging from the existing darkness of economic policy that shrouds the buck would lead to a substantial dollar rally.

Maybe I’m trying to hard to make 2+2 =4.

Jack Crooks.


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