The Strong Dollar Could Turn on a Dime
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Today’s currency war started in 2010. My first book, Currency Wars came out a little bit after that. One of the points that I made in the book is that the world is not always in a currency war but when we are, they can last for a very long time. They can last for five, ten, or even fifteen years — sometimes longer.
It’s really not a surprise that here we are in 2015 talking about currency wars because it’s the same currency war. A lot of what you read or see on the TV will be some policy move by, let’s say, Japan, to weaken the yen. And reporters will say: “There’s a currency war going on”, or “There’s a new currency war.” I just roll my eyes a little bit and think to myself, “No, this is the same currency war; it’s just a new phase or new battle.”
Currency wars have a lot of explanatory power — in fact, they’re one of the most important things going on in economics today. I fully expect that a year from now, we’ll still be talking about it.
What is a currency war?
They typically happen when there’s not enough growth in the world to go around for all the debt obligations. In other words, when growth is too low relative to debt burdens.
When there is enough growth to go around the United States doesn’t really care if some country tries to cheapen its exchange rate a little bit to encourage exports. It’s almost too small to bother with, in the scheme of things.
But when there is not enough growth to go around, all of a sudden it’s like a bunch of starving people fighting over the crumbs. Today is a good example of that.
Today, everybody cares about currency cross rates because they’re a way to either promote exports or import inflation in the form of higher import prices. Remember, when a country lowers its exchange rate, that country’s citizens have to pay more for imported goods.
The United States is a net importer. We buy more from overseas than we sell. And so the immediate impact of a cheaper dollar is to increase the costs of things Americans buy. If the U.S. lowers the dollar exchange rate, it imports inflation, which is exactly what the Fed wants. How many times have you heard the Fed say they want 2 percent inflation? They repeat that target over and over and over.
And yet, we don’t have 2 percent inflation right now. It’s not even close. They need to get there — and one of the ways they do it is to cheapen the dollar. The other effect of cheapening your currency is, of course, it promotes exports.
Take the the United States as an example, again. Boeing Aircraft, which are big ticket items, compete with Airbus, and in Brazil there’s a company, Embraer, in Canada there’s a company, Bombardier. There are a few aircraft manufacturers around the world. Not that many, but we compete with them. And so a cheaper dollar, in theory, helps Boeing sell a few more planes and creates some jobs and growth in the US. So there are perceived to be benefits. Now, a lot of those benefits are illusory.
It’s very, very appealing to politicians because a politician can stand up and give the speech that I just recited, namely: “It’s good to have a cheap dollar because we promote jobs.”
The reality, however, is it doesn’t promote jobs. It just promotes inflation. You’re actually better off with a strong currency because that attracts capital from overseas. People want to invest in the strong currency area, and it’s that investment and those capital inflows that actually creates the jobs. So as usual, the politicians and the central bankers have it completely wrong. But they’re not listening to me or necessarily reading my books.
They think this is a cheap fix. So all around the world, you’re seeing countries cheapen their currencies. They do this basically by cutting interest rates or intervening in markets. They do it ostensibly to help growth. It doesn’t really help growth, it just causes inflation.
Think of a bunch of starving people fighting over a few crumbs. That’s what happens when there’s too much debt in the world and not enough growth. That’s what a currency war is. It’s going on now. It will continue to go on. It has enormous explanatory power.
So when you’re trying to figure out everything else, you’re trying to figure out growth, you’re trying to figure out interest rate policy, you’re trying to figure out sectors to invest in, are we going to get inflation, deflation; all those big questions that investors wrestle with, you can get some clarity and visibility on all of them just by understanding this dynamic of the currency wars.
Now, at the moment, the dollar is strong. I like to call the current U.S. predicament the “Mick Jagger theory of economics”.
Mick Jagger and the Rolling Stones had a song called “You Can’t Always Get What you Want.” And the point is, the Fed wants inflation, but that doesn’t mean they automatically get it because there are other forces at work.
You can understand Fed policy as an effort to cheapen the currency and get inflation. But the dollar is very strong. It’s the strongest it’s been in about eight years. A lot of people think this is the all time high for the dollar. It’s not.
The all time high for the dollar was in the mid ‘80s, in the early part of the Reagan administration. If you go back and look at the dollar index in mid-1980s – that was the all time high for the dollar. That was a pretty good economic period too.
GDP in real terms grew 16 percent in three years. That’s over 5 percent a year — much, much stronger growth than we’re experiencing today. That’s a good example of the point I made earlier, that a strong dollar can actually lead to strong growth because you’re growing with investment and productivity gains.
Today, the dollar is strong again, and the reason for that is very simple. Markets expect US rates to go up this year. They expect our trading partners to continue to print money; namely the Japanese and the Europeans.
If you’re an investor, you think to yourself: “I’d rather invest in the place that is going to give me a return. If I invest in Japan or Europe, I might get a negative return because the currency is going down and the rates are low – maybe even negative. If I invest in the US, I’ll get a positive return because the Fed’s going to raise rates and give me something on my money.”
Therefore, investors are flocking to the United States and that’s why the dollar is strong. Cross rates like the dollar/euro rate or the dollar/yen rate or any rate are determined by capital flows, pure and simple.
Right now capital is flowing into the United States, away from these other countries, partly because the expectation of stronger growth and stronger rates.
That’s why the dollar is stronger today. Now, the question is, will US rates actually go up in 2015? If the answer to that question is no, and I believe it is, then the current strong dollar trend could turn violently on a dime.
This is one of the shocks that investors have to look out for. It might play out as expected, but I actually think there are other forces at work that cut against that and could lead to a rapid turnaround — especially in the dollar/Euro exchange rate in particular. This is a space you need to watch closely.
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