Currencies appreciate and depreciate for many reasons and either extreme isn’t necessarily good or bad. Traditional economic theory holds that a cheaper domestic currency relative to other trading partners reduces imports and boosts exports as our widgets become cheaper from the perspective of other countries and inflation pressures rise as imports become more expensive. In the limited history of free floating global currencies, this accepted model garners too much attention.
When Trump’s Treasury Secretary last week implied Trump wants a lower dollar, the stock market sold off quickly on fears of higher inflation of imported goods and an exodus from US Treasury debt holdings by foreigners. We wrote at the time that this was "fake news" as Mnuchin really didn’t care about the dollar’s value – up or down. Sure enough, the next day Trump came out and stated the opposite, that the US dollar should be stronger. Stocks zoomed back to new record highs as the status quo was preserved.
Mnuchin: “Obviously a weaker dollar is good for us as it relates to trade.” 01-24-18
Trump: “I want to see a strong dollar.” 01-25-18
Trump may actually want a lower dollar, but so much worry over its trajectory is largely unfounded. In the 1970s and '80s when the vaunted Japanese yen was astronomically over valued – triple its current level – their exports were soaring, contrary to economic expectations. In the 1970s through the 1990s, every President demanded a weaker yen and a stronger dollar, assuming this would reduce our huge trade deficit with Japan. That trade deficit with Japan remains close to $70 billion despite an over 70% depreciation of the yen since the 1970s.
Trump has continued the currency bashing tradition with China as our new trade deficit enemy, calling for a stronger Chinese yuan and weaker dollar policy during his Presidential campaign. Such government policies are ineffective as imports and exports “always” move together with the economy regardless of currency trends. There is some evidence that imports grow relatively faster than exports when the dollar appreciates, and the reverse is true to some degree. However, there are many factors more important to trade and inflation than currency values, such as tariffs, regulations and the stage of the economic cycle. When the US dollar rose in the expansinon cycles of the 1980s and '90s, our exports grew at a very healthy pace, yet when the dollar fell in the early 2000s, exports also expanded at a similar rate. Governments should look at their currency as more of a byproduct of economic policy rather than a vehicle to manipulate for an illusive trade war benefit.
There is no solid evidence that a currency value by itself is a benefit or a liability. What’s clear is that GDP and trade move in unison with both strong and weak currencies.
One of the strongest correlations (inversely) with the dollar is oil. Using the inverse oil ETF (SCO) we can see how tightly it trades with the dollar. One the strongest ‘tells’ that the dollar was about to fall occurred in early 2010 and again in late 2016 and 2017 when oil diverged from the dollar. The sharp rise in oil prices (falling SCO) starting in 2016 while the dollar traded to multi-year highs foretold of the sharp 15% dollar correction in 2017. If oil has hit important resistance here between and /barrel, then the dollar should begin forming a base near the late January lows.
More evidence that currencies are given too much importance is in the understanding that not only do exports and imports rise and fall together with an economy regardless of the currency change, but that all major countries essentially move in sync. Currently, the falling dollar is not only showing up as better US exports (& imports), but better exports from all countries around the world where their currencies are rising against the dollar.
Exports rise and fall with the economic cycle, not any currency relationship. The US and global economy along with both imports and exports, all tend to move in unison regardless of rising or falling currency values. Currently, the very broad strength in exports around the world speaks to rising animal spirits in an accelerating stage of the economic cycle as we have been expecting, yet with very low inflation. As the economy heats up in 2018, the broader commodity price index should finally begin to rise along with interest rates as inflation begins to manifest. Given the emerging market excess capacity however, we don’t expect inflation or interest rates to create more than short-term scares in the market as they work modestly higher along with global equities.
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