Looking at the dire prognostications of currency analysts on TV or in the newspapers lately would lead one to believe that all of your assets are evaporating like raindrops on a Phoenix sidewalk in August.
Have you checked the value of your stocks or your real estate lately? In euros? Or British pounds? Has it sadly all disappeared seemingly while you were sleeping?
Looking at the dire prognostications of currency analysts on TV or in the newspapers lately would lead one to believe that all of your assets are evaporating like raindrops on a Phoenix sidewalk in August. Given the depth of the dread, I’m surprised that some of the Wall Street brokerage firms haven’t taken advantage of all this gloom by selling a currency hedging strategy to consumers that would prevent the disappearance of home equity as a result of the declining dollar. Hmmm.
Want to hear the truth? Well, as measured by a basket of currencies all combined into one index for futures that change hands on the New York Board of Trade, the dollar is actually at the same level that it was in 1995. Did the end of the world occur in 1996 and I slept through it?
As usual, the media is confusing Americans by focusing too much attention on excessively negative minutia while ignoring the much larger, global perspective. Yes, the dollar is indeed at all-time lows against the euro, but as the euro didn’t exist in 1995 at the dollar’s last low, we don’t specifically know what it might have been worth back then without extrapolating. Absent such a calculation, as the dollar was weaker against most currencies in 1995 than it was in 1999 when the euro was first introduced at $1.18, it is safe to assume that it would have been worth more than that if it had existed in 1995, and potentially even more than its current $1.32. As a result, today’s exchange rate is by no means a cataclysmic valuation. Feel better?
Something else to assuage your fears with regard to currencies is the possibility that as our stock market was experiencing its bubble phase in the 90’s, so was the dollar. If one were to take a look at an S&P 500 chart, you would notice that as our stock market rallied from 1996 through 2000, it did so practically in tandem with the upward move in our dollar. Why? Well, as stocks were appreciating, foreigners were buying them, and, to do so, they first had to buy our dollar. As such, one could make the case that the dollar was just as overvalued in 2000 as stocks were.
Of course, the dollar didn’t immediately collapse with stock prices in 2000, mainly because moneys seemed to initially just transfer out of equities and into U.S. Treasury securities, keeping the dollar strong through 2001. However, when our economy didn’t begin to truly expand in 2002 as many had expected, a bear market in dollars started that hasn’t ended yet. Likely, this was also precipitated by continued Fed easing that exacerbated the differences between American interest rates and those across the globe. As a result, it is quite likely that until our interest rates head significantly higher, our currency will probably remain very soft.
Let’s look at this more precisely against one high-profile currency just to understand how much interest rates might be at the heart of the problem. Before our recession began in 2001, the Federal Funds rate — the rate the Fed charges for overnight loans to American banks — was 6.5%. By contrast, the corresponding rate offered by the Bank of England was 6.0%. As a result, at that time, an investor could have received a half a percentage point more in interest in America than in Great Britain. However, as our economies declined, and our central banks lowered interest rates to try to spur growth, our funds rate dropped to 1%, while England’s declined only to 3.50%.
What this means is that our bonds and bank savings rates went from paying more than those of England’s in the year 2000 to 2.5% less by 2003. Obviously, this represents a huge motivation for international investors to move money out of America into Great Britain. In doing so, they first had to convert dollars into pounds. Now, consider all of the banks, mutual funds, and pension funds all around the world that wanted to get that higher rate, and you can imagine that a lot of dollars have been exchanged for British pounds in the past three years. Unfortunately, this problem still exists today, for as we have raised our rates to 2%, the Bank of England actually has now widened this gap, as it is currently paying 4.75%. Make sense?
Taking this a step further, in China the interest rate differential is even greater, as its central bank’s key lending rate is currently 5.58% — a full 3.5% higher than ours — thereby enticing money flows into that country. This brings up another issue that the press seems to not want to discuss that is likely exacerbating the dollar weakness across the globe; the Chinese currency, the yuan, does not float. It is instead pegged to an exchange rate against our dollar first established in 1994. This archaic and unfavorable “peg” exaggerates the decline that our dollar is having against the euro and most countries that trade with China. This is one of the reasons that U.S. trade representatives have been begging the Chinese government to allow the yuan to float like other currencies. It is widely speculated that such a move would not only act to reduce our current trade deficit with China by increasing the relative cost of its products versus ours, but might act to abate some of the current upside pressures on other currencies against the dollar.
Of course, this begs the question: Is a weak dollar a bad thing for our economy or our nation? In reality, the answer is NO. One of the most hypocritical aspects of the current carping about today’s dollar weakness is that in the same breath, people are complaining about our trade deficit and how large it is. Well, what’s the best solution for our trade deficit? A weak dollar. Why? Because a weaker dollar makes our products cheaper around the world, and foreign products more expensive here. As a result, the weaker our dollar gets, the more goods and services we will sell overseas (hence, increasing exports), and the fewer foreign products Americans will purchase (hence, decreasing imports). Barring the implementation of trade quotas or tariffs — which America as a free trade advocate should NEVER consider — the best way for us to deal with our growing trade deficit is through a soft dollar policy.
Another unbelievably hypocritical assertion being floated this week was that foreign central banks were going to stop purchasing our Treasury paper because of the declining dollar. Now, I must say that I have been hearing such prognostications for more than twenty years, and it has never come to fruition. In the 80’s, it was Japan and Germany that were going to stop buying our treasuries. Never happened. Last week, it was China. Of course, since its currency is pegged to ours, China is forced to buy dollars as its money supply grows much like a central bank whose currency is tied to gold must keep gold on hand. Additionally, any country that is concerned with preserving its trade surplus with the U.S. would be cutting its own throat by allowing the dollar to further devalue. As such, this dollar boycott speculation is hogwash.
Furthermore, if central banks around the world were beginning to cut back on purchasing our Treasury bonds and notes, wouldn’t we see a decline in the price of these debt instruments? Looking at a chart of the interest rate paid by a ten-year T-note, one will see that this percentage is virtually the same as it was when this most recent decline in our dollar began at the end of August, thereby suggesting no serious reductions in demand for these investments.
So, why is the media focusing so much attention on our current dollar situation, and doing so in a way that suggests a dire condition? Well, in response to Mr. Bush’s huge victory at the polls, the left and the press who supports them have now changed their modus operandi from defeating him to blocking his pending legislative proposals — Social Security reform and tax simplification.
To be sure, nothing offends the left more than tax cuts and the possibility of American employees actually being able to direct their own Social Security contributions. Given this, much as the left and the mainstream media for the past 24 months depicted all economic news in as negative a fashion as possible to try to persuade voters to support Senator Kerry, their goal now is to thwart the President’s agenda by suggesting that his initiatives will have dire economic consequences. This NY Times article asserting that Bush’s Social Security plan will dramatically expand the federal deficit should give you an idea of what they have in store for us.
How is this at all related to the dollar decline? Well, although our federal deficit is certainly a component of the dollar’s decrease in value, it would be naïve to suggest that this is the sole precipitant. However, I fervently avow that in the coming months, we will continue to be barraged with such deficit-to-dollar proclamations. The purpose? To scare the population into believing that not only is a soft dollar a terrible thing for them, but that the President’s Social Security and/or tax simplification proposals will further exacerbate the deficits which, in turn, will yield continued dollar declines thereby hurting the American economy and its citizens personally.
slep@danvillebc.com
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