Market Watch: US Exports its Deficit

Is this deliberate policy?

The US dollar has spent much of the past 6 months hitting record lows against most of the world’s leading currencies, including the pound, the euro and nearly all of the major commodity currencies: the Australian dollar, the Canadian dollar and the Norwegian Krone. The US currency has fallen 20% against the Canadian dollar (the US constitutes 80% of Canada’s exports) since March, 15% against the Australian dollar since August and 7% against the euro in the past 7 weeks. Although the dollar is the weakest of the major currencies in the world this year, US politicians have grown more vocal about the weak Chinese currency (primarily a fixed rate currency allowed to trade within a narrow band with the US dollar) and have been pushing legislative bills to penalise China for its apparent currency manipulation. Yet, is the US guilty of a similar offence and is it allowing its currency slide into the abyss, deliberately. With the US dollar index at an all-time low, many would argue the currency has already reached the abyss, yet having the worst current account deficit per capita of any leading economy, does the US Administration really want a stronger dollar?

Why might the Administration want a weaker currency?

1. With the economy slowing, a weak currency makes US exports cheaper and thus helps to stimulate activity and growth in the country’s export sector.

2. Imports become more expensive and thus US products are more competitive on the home market, again helping to stimulate domestic growth.

3. A weaker currency leads to a narrowing of the country’s trade deficit, thus improving the country’s current account and international debt liability.

4. Attracting greater foreign investment (it is now cheaper for investors to buy dollar denominated assets).

5. Encouraging greater numbers of tourists and thus greater consumption of US goods.

6. The value of the country’s own foreign currency and gold reserves increases and the net liability of previously issued debt in relative terms is reduced.

The dangers of a weaker currency ?

1. Imported Inflation. Essential imports like energy are rising in price not just on increased global demand, but also because of a weaker dollar (all major commodities are denominated in dollar). This means the US will be paying more than other countries for oil, gas etc. and the inflationary impact of higher prices will be greater in the US than anywhere else.

2. Dumping of dollar denominated assets. If investors believe the dollar is going to depreciate more and more in the longer run, they will be tempted to offload their assets sooner rather than later. The sharper the dollar decline, the more acute the investor panic and this could lead to a major dump of dollar denominated assets and by consequence higher US inflation.

3. No takers for US debt. If the yield on US bills is less than the dollar’s level of depreciation, then the attractiveness of holding US debt is diminished. Indeed, in such a scenario the only nations for whom it makes sense to continue to buy dollar-denominated asset paper would be those countries that have a currency that is aligned to the US dollar, like China and the oil-exporting nations of the Middle East. Continued dollar depreciation could force the oil-rich countries of the Middle East to break their alignment to the dollar, so as to preserve the value of their oil revenues.

4. China. Arguably the one country that benefits more than the US from a weaker dollar is China. With its currency directly aligned to the dollar, the conversion of its revenues from exports to the US into the local reminbi currency is primarily the same, regardless of the value of the US dollar. As well as this, a weaker US dollar, means a weaker reminbi relative to other world currencies and makes Chinese exports to other parts of the world all the more competitive. Also, if China continues to be the major holder of US debt, more and more control of the US economy and economic destiny will be given to the Chinese.

5. Stature. The US likes its mantle as the world’s dominant economy and owning the world’s premier currency. The dollar may become secondary in importance to the euro, or the reminbi, if it loses its credibility and role as a ‘haven’ currency and this could greatly weaken the economic influence of the US in the world.

6. A Dollar crash. Though unlikely, it is conceivable that the US dollar could become such a liability that nobody wants to hold it and a wave of panic selling / speculative overdrive could lead to a capitulation of the currency, like that seen for some Eastern currencies during the Asian financial crisis. A collapse of the dollar would plunge the world economy into crisis, but the world’s central banks and governments are unlikely to allow that to happen, not while it remains the predominant currency anyhow.

So is a weak dollar US government policy?

It is very difficult to prove but what we do know is that the current Administration has paid only lip service to the decline of its currency, so this indicates they’re untroubled. The Fed’s decision to cut rates aggressively and thus add liquidity to a domestic economy already heavily indebted, demonstrates the Fed does not expect today's US consumer to pay for the country’s massive deficit, at least not in the foreseeable future. Short-term economic gain is better than long-term pain for future generations of Americans – could this be the Fed’s thinking, or is it a case of weakening the currency to shift the US deficit problem to other parts of the world. Either way, it’s a massive gamble and somebody, somewhere will be left holding the tab.


Ted B - Oct 11