Friday, May 12, 2006

Currency Markets and the Falling Dollar

Having watched the currency markets quite closely over the past year, I have made a few macro observations about currency swings in relation to the US Dollar (USD):
  • Regardless how good the economic news should be for the USD, the greenback is slow to make gains against other currencies;
  • Regardless how small any bad economic news is for the USD, it will quickly lose ground to other currencies;
Now, I have also noticed that regardless of how much the US Treasury and other government agencies speak of a "strong dollar policy", there is nothing to back that up. In fact, many actions seem to enfore the opposite, including:
  • Rampant Federal and State spending, and incredible amounts of deficit spending (and debt buildup as a percent of GDP) to say the least;
  • Inability to get China to float their currency in a more realistic zone of worth (perhaps as much as a 40% revaluation);
  • Massive "sucking sound" as cash is headed out of the USA to literally fuel our economy (read: USD is headed to the middle east and other oil producing countries);
  • Tax policy (and foreign and domestic policy too!) that, I feel, is eroding the standard of living in the USA with a direct assualt on the middle class!
Perhaps it is just coincidence, but as recently as 2001, the USD was very strong against foreign currencies such as the New Zealand Dollar (NZD). Just take a quick look at the NZD Historical Rates, and correlate them with the US Debt as a percent of GDP mentioned above. Tight correlation. By the way, the NZD makes a fairly good "baseline" currency to measure against since the country has negligible national debt, and has been that way for a while.

With the China situation, we are shipping money out of here at a record pace. We consume their manufactured goods at a record pace, while they build their account surplus (at the expense of our account defecit) month after month. Add to it all the investment that USA-based firms are making into China (instead of here), and you compound the movement of the USD.

That "sucking sound" I mention above is quite loud. Just look at the other side of the equation, where the producers like Saudi Arabia have seen their Net Foreign Assets surge. This trend is likely to continue, putting further pressure on trade imbalances, and increased currency dilution for the USD. If that was not bad enough, all of the (unfriendly) oil producers have figured out the greatest thing about being an oil producer -- simply rattle your sabres, make threats, and talk up the cost of oil, and you can easily raise the price of your own product! Wow, if only we could all just make a fuss and issue threats to our customers every time we wanted to increase the price of our product... what a world it would be.

When it comes to Tax Policy, this is a whole story of its own. I'll get to that part of the equation later.

Bottom line: until the macro-economic forces discussed above are addressed, the dollar will have strong headwinds preventing it from quickly regaining ground. Which, is why I presume the falls for the USD are faster than any subsequent partial-recoveries.

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