U.S.: The Dollar Is Strong. Get Used To It
America is riding high--and so is its currency. That's because the unrivaled mix of strong growth, low inflation, appealing interest rates, and fiscal stability has been a magnet for foreign capital. From April, 1995, to April, 1997, the trade-weighted dollar soared 19% to its highest level since 1989, as investors traded in their Japanese yen and German marks to snap up everything from Treasury bills to shares of the latest U.S. high-tech winner. The surging dollar's impact has been felt both at home and abroad, and the greenback will continue to play an important role in the outlook for the rest of the year and into 1998.
But while some of the results from the dollar's runup have been predictable, some have not. For example, the muscular dollar is prompting fears that higher prices of U.S. goods in foreign markets will cut into exports, and that earnings from operations abroad will get creamed as they are repatriated at the higher dollar value. But to the contrary, exports are still accelerating at a time when the dollar's impact should be showing up. And because of resilient exports, foreign profits are holding up surprisingly well (charts).
The strong greenback is also wreaking havoc in other countries that link their own currencies to the dollar. In fact, several currencies in Southeast Asia have collapsed, after becoming overvalued relative to their countries' economic fundamentals, and that turmoil is raising questions about future U.S. trade flows. But barring a further ballooning of the problem, the impact should be limited, because U.S. trade exposure to the region is relatively small.
WHERE THE DOLLAR'S STRENGTH is having its greatest--and most predictable--impact is on import growth and inflation. Amid robust U.S. demand, cheaper imports are grabbing an ever-larger share of U.S. spending, widening the trade deficit, and curbing economic growth. At the same time, the 4% drop in import prices of nonoil goods in the past two years has cut a half-point from this year's consumer inflation.
What is behind these reactions to the buoyant buck, and how will they play out? Let's look at them one at a time. First of all, exports have not even flinched during the dollar's ascent. Although exports of goods and services dipped 1.4% in July, based on the latest trade data, half of the decline reflected a drop in shipments of nonmonetary gold, an often volatile category. Still, adjusted for inflation, exports of goods are up 26.5% from a year ago, a sharp speedup from an already sturdy 15.4% growth rate during 1996.
Foreigners are buying a wide range of consumer goods, autos, and capital goods, especially computers and aircraft. In fact, Boeing Co. recently announced that shipments of several commercial jets would be delayed due to heavy demand. The data argue that past cost-cutting and productivity gains have given U.S. manufacturers increased competitiveness in world markets, even at today's higher exchange rates.
Moreover, surprisingly strong growth abroad is swamping the negative effects of the dollar's rise. In the year through the second quarter, the Canadian economy grew 3.7%, up from 1.2% a year earlier, and growth in Mexico was 8.8%, up from 6.4%. Those two countries account for 33% of U.S. exports. In Europe--24% of foreign demand--growth in Germany and France is twice as fast as a year ago, and Britain has picked up as well.
Meanwhile, Latin American economies other than Mexico, which chip in 8% of exports, continue to perform well, although the stronger dollar is being felt there, especially in Brazil, which loosely ties its currency to the U.S. unit. Brazilian imports are surging, widening the current-account deficit, and raising fears of a forced devaluation, a la Thailand.
AS FOR PROFITS, amid persistent export gains, earnings from foreign operations have held up, although they are growing more slowly. In the first half of 1997, profits from abroad were up 6.3% from the first half of 1996. For all of last year, they grew 10.7%, after jumping 18.2% in 1995, when the dollar hit its low point.
To be sure, multinational giants like Coca-Cola Co. and Gillette Co., which generate the bulk of their earnings overseas, have felt the greenback's pinch. But in the bigger economic picture, foreign earnings account for only 13% of total corporate profits, and it is the slowdown in domestic earnings growth, to 7.4% in the first half, from 13% in 1996, that has been primarily responsible for the slower pace of overall corporate earnings so far this year.
The dollar is also making waves in Southeast Asia, but don't expect a big impact on the U.S. economy. The four countries that have suffered the largest devaluations--Thailand, Malaysia, Indonesia, and the Philippines--account for only 4% of U.S. exports and 6% of U.S. imports. Mexico is a much bigger trading partner, and the overall impact of the peso devaluation in 1994 amounted to a subtraction of only a couple of tenths of a percentage point from U.S. economic growth in 1995.
Also, given the small impact on trade, the trade-weighted dollar will show little additional upward pressure. Indeed, the trade-weighted value in mid-September is about where it was in April, before the currency chaos began (chart).
FINALLY, THAT BRINGS US TO the dollar and imports. To be sure, as the Southeast Asian economies begin to recover from their currency-induced slowdowns, their upturns will be export-led. And given the strength in both U.S. demand and the dollar, U.S. shores will be a key destination. Imports of goods and services continued to surge in July, rising 1.1%. Adjusted for inflation, imports of goods are up 22.7% from a year ago. As a result, the trade deficit continues to widen. It rose to $10.3 billion in July, well above the $8.9 billion average in the second quarter.
Despite the sparkle in exports, the 1997 trade balance is on its way to the widest deficit since 1987. That's because, in the second quarter, a record 30% of domestic demand for nonoil goods went to imports. Based on the July data, that pattern continued in the third quarter, and the further widening in the trade gap may subtract a big chunk from third-quarter economic growth. At the same time, however, cheap imports continue to hold down inflation.
Looking ahead, forecasting the dollar is always a risky business, since political as well as market forces are always in play. However, the recent round of appreciation appears to have peaked, and without any further runup, whatever impacts the dollar has brought to bear on trade, profits, and inflation will gradually wane. But until economic growth and interest rates turn up decisively in both Japan and Germany, the dollar seems likely to remain strong, probably into 1998. Where else would you rather invest your money?