Countries want cheaper currencies to sell more commodities.

Photographer: Andrey Rudakov/Bloomberg

Commodity Exporters Like Cheaper Currencies

A. Gary Shilling is president of A. Gary Shilling & Co., a New Jersey consultancy, and author of “The Age of Deleveraging: Investment Strategies for a Decade of Slow Growth and Deflation.” Some portfolios he manages invest in currencies and commodities.
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The U.S. dollar is strengthening for reasons that go beyond deliberate devaluations of the euro and yen. Major commodity exporters are also purposely pushing down their currencies as commodity prices drop. The Canadian, Australian and New Zealand dollars as well as the Brazilian real, Russian ruble and other emerging economies are all playing this game. 

Previously: Why Countries Wage Currency Wars

Those countries want weaker currencies to offset declining commodity exports. In the past year, the head of the Reserve Bank of Australia has expressed sympathy for a weaker Aussie in view of soft mineral exports and a moderately growing economy. 

Recently, the head of the Reserve Bank of New Zealand said that, even with the drop in the New Zealand dollar, the kiwi is at “unjustifiable” levels and isn't reflecting the weakness in the global commodity market. Earlier, the kiwi was propelled by strong meat and dairy exports to China and robust prices for milk, which have plunged. New Zealand's economic growth is in jeopardy. 

The Bank of Canada recently left its benchmark interest rate unchanged at 1 percent and expects inflation to be near its 2 percent target. But a decline in energy and other commodity prices has hurt the Canadian economy, which is growing at the same slow 2 percent rate as the U.S. 

The commodity bubble in the early 2000s prompted producers of industrial commodities, such as copper, zinc, iron ore and coal, to increase production. New output resulted just in time for the price collapse in the 2007 to 2009 recession. 

The subsequent rebound didn’t hold and commodity prices have been falling since early 2011, no doubt due to excess supply of industrial commodities and slower growth in China, the world’s biggest commodity user. The price decreases are also due to sluggish expansions in developed countries and, in the case of agricultural products, good weather and more acreage being planted. 

So far this year, grain prices are falling, as are industrial commodity prices. Crude oil prices rose until mid-June, but have since dropped 25 percent and now are the lowest in six years. Spurred by fracking, U.S. oil output is exploding as economic softness in Europe and China and increased conservation have curtailed consumption. Copper, which is used in everything from plumbing fixtures to computers, is dropping in price as supply leaps and demand lags. 

As discussed in a previous series, China faces a host of problems, including slower growth -- an inconvenience for the many commodity exporters who rely on China to buy their products. China consumes more than 40 percent of the world’s output of copper, tin, lead and zinc and huge amounts of coal, iron ore, petroleum and cotton. 

Rapid economic growth covers a multitude of sins, especially in a developing country like China, where it’s needed to provide adequate jobs. It glosses over inefficiencies and a fair amount of graft and corruption. In contrast, slow growth magnifies economic and social ills and favors those with political power. 

Evidence of slowing growth in China is rampant. It can be seen in declining purchasing managers’ indexes. China's industrial production and retail sales growth are falling, its export growth remains sluggish and property prices are falling as a housing bubble deflates. 

China’s past response to slower growth was stimulus in the form of more bank loans and infrastructure and capital spending projects, often aimed at increasing exports. Those massive efforts led to undesired inflation, an explosion in loans and a property bonanza, leading Chinese leaders to take steps to cool down the lending spree. 

Official GDP growth in the third quarter was 7.3 percent, the slowest pace in more than five years. The true growth rate, however, is probably more like 4 percent. In a sign that the leadership thinks the deceleration has gone too far, China's central bank last week surprisingly cut benchmark interest rates to rev up the growth engine again.    

Another force that’s elevating the U.S. dollar against other major currencies is the carry trade. With positive spreads between the yields on 10-year Treasury notes and those of Germany and Japan (and even less creditworthy Spain and Italy), it’s attractive to sell those sovereigns to buy Treasuries. 

The spreads are small, but with a leveraged position, the carry trade can be very profitable -- and even more so as the dollar appreciates. Who would want to own a 10-year German bund yielding 0.83 percent with a falling euro, or a 10-year Japanese government bond returning 0.47 percent as the yen drops, when the 10-year Treasury note yields 2.5 percent and the dollar is climbing? 

In times of trouble, the dollar is the world’s safe haven. Foreigners flock to Treasuries and other dollar-denominated investments, elevating the greenback’s value.

With deliberate devaluations and currency declines spawned by falling commodity prices and slow economic growth, most of the major currencies are dropping against the U.S. dollar. As the world’s reserve and trading currency, the greenback can’t easily be devalued. 

The buck fell 52 percent from its peak in 1985 and has only recovered 8.2 percentage points of that decline. More strengthening is likely. Tomorrow I’ll run through the investment implications of all this.

This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.

To contact the author on this story:
A Gary Shilling at insight@agaryshilling.com

To contact the editor on this story:
Paula Dwyer at pdwyer11@bloomberg.net