The value of the U.S. dollar significantly influences economic prospects in this country and in many other nations around the world. A stronger U.S. dollar makes the products of countries with weaker currencies cheaper to U.S. consumers. Conversely, a weaker U.S. dollar makes our products more affordable to consumers in other nations. U.S. exporters love the weaker dollar, which magnifies profits earned overseas. A weaker dollar has a deleterious effect, however, on U.S. consumers who face higher prices on imports. In general a weaker dollar exacerbates inflation.
The graph below illustrates the value of the U.S. dollar compared with a basket of the world’s major currencies since 1983. The graph is one of hundreds produced daily for a very reasonable subscription price on DecisionPoint.com, a wonderfully rich site for a great variety of economic and securities market data.
From its peak in 1985, the U.S dollar plummeted in value over the next three years. The dollar then traded in a range from about 80 to just over 100 until the turn of the century. It jumped by about 20% from Y2K to early 2002 as stock prices around the world fell precipitously.
Then began more than a 40% loss of value from early 2002 to early 2008, interrupted by only one decent 15% rally in 2005. As the dollar reached the low 70s in 2008, expectations were nearly unanimous that U.S. economic conditions were so weak that lower dollar values were almost inevitable.
Confounding the majority, dollar values today are more than 20% above 2008’s lows. As typically happens, sentiment follows price. Unlike the misplaced pessimism rampant when the dollar was at its lows, more than 90% of currency analysts today expect the dollar to continue higher despite its recent strong rally. We share their confidence, but not in the short run. Too many optimists make us suspicious that this leg of the dollar rally has probably run its course. At extremes, optimism and pessimism are excellent contrary indicators. While we believe the prospects decent that we could eventually see another dollar rally of 10% or more, we think it likely that the dollar price will pull back for a few weeks to a few months to correct the past half year’s strong rally.
Long-term skeptics of the dollar’s prospects point to our country’s horrible and worsening debt condition. While we share that long-term concern, we see some intermediate-term dollar advantage as described in PIMCO CEO Bill Gross’s analogy of the dollar as “the least dirty shirt” in a closet of soiled clothing.
Regardless of U.S. economic prospects, there is a demand for dollars to satisfy maturing world debts, a disproportionate number of which are denominated in dollars. In a world still locked firmly in a deleveraging cycle, there will likely remain a significant demand for our currency for at least a few more years.
The consequences of dollar value changes are obvious for importers, exporters and people who move frequently between countries. They are less obvious for those whose lives are mainly domestically oriented. Dollar fluctuations will, however, affect all of us to one degree or another. And an accurate anticipation of dollar direction will certainly give investors an advantage.
While there are a great many variables and very few one-to-one correlations, a strong dollar generally helps stock and bond prices. A weak dollar, often accompanied by inflation, rewards owners of hard assets like gold, commodities or real estate more than owners of paper assets.
There are infrequent periods, of course, in which virtually all asset prices fall. A deflationary debt collapse, for example, would damage the prices of all assets except the most creditworthy bonds. While we are not forecasting that outcome, the world’s monumental debt overload brings its potential into play. For that reason, we have warned repeatedly of the tremendous danger to stock and municipal and corporate bond investors should the various government-crafted rescue programs fail to maintain a high level of investor confidence.
Tom Feeney is the chief investment officer for Marathon Asset Management Co, a registered investment advisor with the Securities and Exchange Commission, and for Mission Management & Trust Co., a full service trust company regulated by the Arizona Department of Financial Institutions. If you would like to explore the management of an investment portfolio of $1 million or more by either of the firms, you are invited to email your interest to Tom@missiontrust.com or call (520) 529-2900 to speak with one of the Portfolio Coordinators.