Money Money Money
December 30th, 2003 - 12:01 am
We’ve seen this headline so many times in the last year, I’ve lost count:
Euro: New Record High vs. the Dollar
So where does the euro now stand? It takes more than a buck and a quarter to buy one.
Let’s put that into a perspective I can understand. I went to Germany in 1984, when on a good day, you could get 2.80 Deutschmarks for a dollar. Then came the Great Devaluation, when our twin deficits (current accounts and federal spending) caused the dollar to drop to about 1.80-2.00DM. When the euro went into effect, it was worth about two DM
Good stuff Vodkaman.
The obsession with the trade deficit is a big pet peave of mine. Why does the relative relationship between imports & exports matter? They are different products and different customer bases. The cyclical relationship (where dollars leave for VCRs, etc and come back to purchase stocks & bonds) still doesn’t matter.
What matters is the trend for imports and exports. If they are both up, that tends to imply a good economy, if both are down, the economy is doing bad. If memory serves, the lowest the trade deficit has been in the last 20 years was during the Bush 1 recession. And Germany & Japan have regularly held trade surpluses and this has not shown any positive impact to their economies.
You say that things will stabilize. I’m not sure things aren’t stabilized. These things tend to change for a variety of reasons. ANd isn’t it possible the euro is higher specifically because of France & Germany breaking the stability pact? There government securities are probably for sale by the bushel (got to finance that welfare state after all) and that increases the demand for euros? So, a higher euro is the result of poor economic policy? The value of the dollar and trade deficiit are economic factors that are very low on the level of importance, or at least in importance as an economic indicator. GDP growth, unemployment, income growth, corporate profits, inventories and the stock indices are way way more important for figuring out the health of the economy.
Obviously, this is a generalization. If the dollar got TOO low or TOO high, then there are reasons for concern. But still, a high euro does nothing to make me think European economic policy is doing anything positive for their citizens or the world.
Anyone who bets against the U.S. dollar is a fool.
Anyone who bet against the dollar this year is a fool who made a very healthy return for himself.
As a US company which receives much of its revenue in foreign currency, especially the euro, F/X for 2003 has been a very very good thing for us.
Vodkaman:
To what extent is a strong dollar better or worse for the US than a weak dollar?
In terms of exports, clearly a strong dollar is worse. But does that mean that a weak dollar is more likely to lead to a re-thinking about reserve currencies?
More important, what do you think is driving DOWN the dollar, especially as the economic indicators move up? Is this currency manipulation? Is this lack of confidence in the strength of the recovery? Questions about the future deficit?
Can Soros make THAT big a difference, especially if the economy DOES recover? I’d almost think, in terms of upsetting the economy, that a STRONGER dollar would do worse. Granted, a weak dollar makes oil more expensive—but a strong dollar hits at the exporters, weakening their competitiveness.
But, then, I’m not an economist by training or inclination.
The risk of a high trade deficit is that it requires continued foreign capital investment to sustain. This is fine when things are good, but it can create global problems if things go bad.
Here’s what happens: we buy $500 billion more than we sell in products and services. That means there are $500 billion dollars out there that have to go somewhere, either under a mattress or in the bank or wherever. People like to get a return on their money, so they invest it. That means either a) buying U.S. assets like bonds, stocks, or real estate; or b) selling the dollars for another currency and buying foreign assets like bonds, stocks, or real estate.
As long as the dollar is stable or climbing, and U.S. markets are offering safe investments with decent returns, then our excess dollars overseas will keep flowing back into the U.S. in the form of investment. (Meaning, we’re selling our land and businesses, and borrowing $$ to buy cheap plastic crap from China, but that’s another rant.)
The problem occurs when those investments in the U.S. stop looking so attractive. Either they are losing value, or the dollar is sagging so that the investment returns can’t compensate for the currency drops. When that happens, suddenly that $500 billion per year starts getting sold on the foreign currency market to buy yen or euros or something that can be invested in non-U.S. markets. And when there are more sellers than buyers, the dollar drops in value until the market equalizes.
That, unfortunately, depresses the U.S. investment market further. At some dangerous tipping point, foreign investors start selling the investments they’ve already made — like the tens of billions in U.S. t-bills the Chinese own — for dollars, which they then sell on the open market again, increasing the speed of the dollar’s decline.
And, since we still need the money and no one’s buying U.S. equities or corporate bonds, we then have to borrow it, meaning issue t-bills. And since the dollar’s falling and no one wants to hold U.S. assets, the government has to raise interest rates until they are high enough to attract foreign capital — which we can’t get as much of, since the value of the dollar has declined so much. The higher price (in dollars) of imports then creates increased demand for domestically produced goods and services, which generates inflationary pressure (basic supply and demand curve). Meanwhile, the government’s need to borrow has jacked up interest rates and pulled investment capital out of the domestic economy (why make a risky bet buying corporate bonds when you can get a decent interest rate on U.S. Treasuries?), so things are going to be stagnant in all the sectors that matter — business investment, housing, etc. Not good.
Jeez, I sound like Krugman, don’t I?
The antidote is simple: sustain the U.S. economy’s recovery, improve the government’s fiscal picture, ensure that the U.S. remains an excellent place to invest, and crack open the door on some economies that are still pursuing export-driven protectionist growth. Existing industrial capacity should prevent inflation in the short term, giving the world a chance to reappraise the relative value of the Euro, Renminbi, and the dollar.
That’s all well and good, but if this keeps up, I’m going to have to sell the dog into slavery to pay for my Greek honeymoon next year…
Regarding the low value of the dollar, the logical explanation to an economist is that US interest rates are so low: This makes US investments relatively unattractive, which reduces global demand for the dollars that would be used to buy US investments. The lower demand for the dollar reduces its equilibrium price (i.e., the foreign exchange value of the dollar).
Regarding Soros, not a problem. Even major central banks such as the Fed have a very hard time operating effectively in fgn exchange markets because they’re so huge (last time I checked, dollar value of FX markets per week was more than $5 trillion!). As an example, see the Bank of Japan’s recent problerms in keeping the value of the dollar where they want it vis-a-vis the yen. They do an intervention, then a couple of days later the yen-$ exchange rate starts creeping back in the undesired direction.
The reason that a strong dollar is important is that I want to be able to buy stuff cheap when I travel to foreign countries. A weak dollar means a less grandiose hotel or fewer antiques.
Sure a weak dollar may be great for tourism destinations in the USA (remember when the Japanese traveled the USA like nobody’s business?), but being that I don’t own a hotel or restaurant at Disneyworld that doesn’t do a whole lot for me. Give me 55 baht to the dollar and I’ll show you a good trip to Thailand.
Re the collapse of the euro: 1-2 years, not 10-20.