U.S. (Mostly) Wins With Strong Dollar
The forces pushing up the dollar, as discussed in the first two parts of this series, are likely to persist in the short run. Among them are deliberate devaluations of the euro and yen, weakness in commodity-driven currencies, slower growth in China, the carry trade, the dollar’s safe-haven appeal and developing-economy woes.
The greenback is also likely to remain strong in the long run. To put it into perspective, the dollar reached a peak against major currencies in 1985, then slid 52 percentage points over the next 25 years. It's been rising since August 2011, yet has recovered only 8 percentage points of that 52-point slide. Of course, there’s no assurance that the dollar will regain its 1985 peak, yet there are concrete reasons to expect it to remain strong over the long haul.
Part II: Why Countries Wage Currency Wars
China wants the yuan to be a global currency but not at the expense of tight government control. Earlier suggestions that the euro might rival the dollar have been replaced by worries over whether the Teutonic North and the Club Med South can remain under one currency. There is no common fiscal policy in the euro zone and none is likely, considering the region's vast cultural and economic differences. The Japanese government is taking small steps toward globalizing the yen, but fundamentally doesn't want the yen to be an international currency.
You might expect a strengthening dollar to depress U.S. economic growth by encouraging cheaper imports and reducing more expensive exports, but the actual effects are small, as are the resulting deflationary pressures. When a currency strengthens, exporters don’t pass on the cost to buyers but shave their profit margins to avoid losing sales.
Conversely, importers don’t pass all of the currency's rise onto customers, and instead fatten their profit margins. These actions explain why import-price volatility is only about a third the volatility of a currency.
Instead, the principal force affecting imports and exports is economic growth. When an economy is growing, consumers and businesses buy more of everything, especially imported products. The correlation between U.S. imports and the dollar is weak, but the relationship between imports and GDP is strong. My firm’s statistical models show that imports rise 2.8 percent for each 1 percent rise in GDP, but fall only 0.1 percent for each 1 percent rise in the dollar.
Nevertheless, the rising dollar has depressed U.S. corporate earnings. With 46 percent of S&P 500 company revenues coming from abroad, the strengthening greenback is negative in two ways. First, to the extent the dollar's strength is due to weak foreign economies, foreign sales and earnings will be lower.
Second, foreign earnings convert to fewer dollars when the dollar is strong. U.S. companies with major foreign exposures include Alcoa, Ford, GM, Coca-Cola, McDonald’s, Wal-Mart and Procter & Gamble.
Of course, many companies hedge their foreign exposure, but the amount varies and isn't generally disclosed. In any event, investors recently have taken a dim view of the stocks of major U.S. companies that depend heavily on foreign operations and exports.
At the same time, the rising greenback attracts foreign investment, which promotes domestic economic growth and a stronger currency. The appreciating dollar and stability of the U.S. continue to attract wealthy foreigners to real-estate markets in New York City and elsewhere, even with the prospect of very low returns.
A climbing dollar encourages investment by foreigners in U.S. assets because of the currency gains on top of U.S. domestic appreciation and income. Also, the foreign money flowing into Treasuries, with their safe-haven appeal rivaling that of the dollar, helps keep interest rates low, to the advantage of the U.S. economy.
To be sure, all of this assumes that U.S. real-estate and portfolio investments are otherwise attractive. A rising currency in the midst of a major bear market isn’t likely to attract many foreign equity buyers.
Of course, the climbing greenback opens the possibility of profits in currency trading. Portfolios I manage are long the dollar against the deliberately devalued euro and yen, as well as British sterling and the commodity currencies in Canada, Australia and New Zealand.
The dollar has been the primary trading and reserve currency since World War II and is likely to remain so for decades. Rapid growth in the economy and per-capita output weigh in the dollar’s favor. American financial markets are broad, deep and transparent, as is the economy. Despite the dollar's decline since 1985, its credibility is substantial. And there is no real substitute for the dollar as a global currency.
This column does not necessarily reflect the opinion of Bloomberg View's editorial board or Bloomberg LP, its owners and investors.
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