Economic Perspective
FAQ's
Will the U.S. dollar continue to fall?
Why does the value of the U.S. Dollar matter to me?
What has caused the U.S. Dollar to fall?
Why is gold the ultimate hard currency?
What is the impact of Chinese yuan appreciation? |
Economic Perspective
One of the U.S. economy’s greatest attributes has been its flexibility, in large part a result of the allowance of free market forces. While massive monetary and fiscal efforts in the U.S. and globally may have compromised these free market forces, we believe they will play out over the long-term. In our opinion, the U.S. dollar is a natural valve to allow the U.S. economy to adapt to global market dynamics; we consider both free market forces and the unintended consequences of monetary and fiscal policies may push the U.S. dollar lower over the long-term.
The recent financial crisis has in many ways exacerbated the global imbalances that concerned us leading into the crisis. Of grave concern is the unsustainable federal budget deficit, which may have morphed out of control. More worrying still, is that despite a lot of political grandstanding and rhetoric, we are yet to see any tangible evidence of fiscal restraint from either political party. Contrast this with the stance taken by many other governments around the world, which have enacted stringent austerity measures. With a sluggish economy likely to hamper tax revenues, we are unlikely to see any marked improvement in public finances over the near-term. The notion of a balanced budget seems a very distant thought when overlaying the near-term outlook with the budget implications of long-term obligations, such as Medicaid, Social Security and Medicare.
Put simply, the fiscal position of the U.S. has deteriorated significantly, and we consider the outlook remains challenging. We believe this situation is likely to wear away at the safe haven status the U.S. has held for so long. As alluded to above, many other countries have been more fiscally prudent and now find themselves in much healthier fiscal positions relative to the U.S.
The U.S. current account (trade) deficit remains at unsustainable levels, despite recent improvements. The current account balance is what the U.S. earns from other countries (exports, services, investments abroad) less what the U.S. pays to other countries (imports, services, loans). More...
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The balance on trade (the difference between exports and imports of goods and services) is the largest driver of the U.S. current account deficit. In our assessment, the narrowing of the deficit in 2009 was attributed to a weak U.S. economy and consumer, rather than the strength of the U.S. export sector – in fact, the economic downturn caused both exports and imports to fall, it’s just that the rate of decline was more pronounced for imports given the weakness of the U.S. consumer. To put the present current account deficit into perspective, the net shortfall between what the U.S. earned and what the U.S. paid in 2010 was $470.9 billion. Another way to look at this number is that foreigners had to purchase nearly $2 billion worth of U.S. denominated assets (such as U.S. Treasuries) every single business day just to keep the U.S. dollar from falling.
Additionally, we believe the Federal Reserve’s (Fed) actions will likely result in continued devaluation of the U.S. dollar. When a central bank substantially increases the money supply, all else held equal, the central bank causes inflation, a devaluation of the currency’s purchasing power. The Fed has been one of the more prolific money printing central banks around the world, increasing its balance sheet more than threefold since the beginning of the global credit crisis (in simple terms, a central bank’s balance sheet can be thought of as money that has been printed). In our opinion, there is a significant divergence in monetary policies around the world, with the majority of other central banks not following such easy monetary policies relative to the Fed. In contrast to the Fed, other central banks appear more reticent to conduct quantitative easing or implement other "non-standard" monetary policy measures. The composition of the Fed’s balance sheet also gives us cause for concern: in our view, the massive amount of agency mortgage backed securities (MBS) the Fed has purchased will create extreme levels of inflexibility on the Fed’s balance should inflation break out, reducing the Fed’s ability to counteract such an occurrence. Furthermore, the Fed's large-scale purchases of long-term Treasuries creates disruptions regarding key metrics of market ascribed economic forecasts, potentially hampering the effectiveness of monetary policy. Additionally, the Fed's purchases intentionally overvalue those same securities, incentivizing rational investors to look elsewhere for less manipulated returns, putting further downward pressure on the U.S. dollar.
While we see considerable risks domestically, we believe there are attractive international investment opportunities. On a long-term view, we anticipate that Asia may outpace most western economies, including the U.S., attracting global investment and putting upward pressure on the value of many Asian currencies. Many Asian nations have substantial surpluses and much healthier fiscal positions than the U.S. Moreover, most countries in the region have focused on growing their domestic economies, spending on the likes of infrastructure, growing the middle class and urbanizing the workforce. A likely side effect of such rapid domestic growth may be increased inflationary pressures. In our view, allowing these currencies to appreciate may be an effective way to address and mitigate domestic inflationary concerns. As such, inflationary pressures may force the hand of Asian countries following tightly managed exchange rate policies, such as China, to allow their currencies to appreciate.
Strong, ongoing Asian economic growth will likely sustain the demand for commodities and natural resources. Countries rich in such resources may fare well, and ongoing Asian demand will likely benefit the currencies of such nations over the long-term. We consider that countries whose governments display greater fiscal restraint and responsibility will increasingly be viewed as sought after sources of stability; over time such countries may supplant the U.S. as safe haven investments. Additionally, in our assessment, the monetary policies pursued by central banks globally will have a marked impact on currency valuations over the long-term. Relative to the Fed, we believe many international central banks are more effectively fostering an environment of price stability and as such, the currencies of such nations may retain significant value relative to the U.S. dollar. Consequently, on a long-term view, we favor the currencies of nations that are well placed to benefit from ongoing Asian economic growth, display fiscal restraint, and whose central banks’ pursue prudent monetary policies.
Will the U.S. dollar continue to fall?
While we cannot say with certainty that the U.S. dollar will decline, we believe there is considerable risk of a continued decline in the value of the U.S. dollar going forward. Numerous factors are apparent that contribute to our view. Relative to many other nations, the fiscal health of the U.S. has deteriorated significantly in the aftermath of the credit crisis, as evidenced by the untenably large Federal government deficit. The Federal Reserve’s (Fed) policies have substantially inflated the Fed’s balance sheet and created inherent levels of inflexibility and, in our opinion, inflationary pressures. We consider these two developments will not only wear away at the safe haven status the U.S. has held for so long, but the consequences of such policies give us cause for concern. We believe a likely result may be further devaluation of the U.S. dollar.
Structurally, the U.S. current account deficit remains at unsustainable levels, while substantially higher economic growth rates and more attractive investment opportunities are likely to be found outside the U.S., attracting capital to such regions. All of which does not bode well for the value of the U.S. dollar; we believe considerable risks remain on a long-term view.
To read about our long-term economic views, please see our Economic Perspective.
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Why does the value of the U.S. Dollar matter to me?
A night in a hotel in Europe on October 25, 2000 charging €100 would have cost you less than $83; the same hotel, had it kept its price unchanged at €100, would have cost you over $143 on January 1, 2010 – more than a 72% cost increase in U.S. dollar terms.*
At first glance, you may not care much about the cost of a hotel in Europe if most of your expenses are in U.S. dollars and inflation has been tame over the past couple of years. However, one of our key concerns is the inflationary impact of present market interventions and policies. Furthermore, if a currency loses value relative to other currencies, this may compound inflationary pressures, as imports become more expensive.
Even if you personally don’t buy anything directly from abroad, U.S. corporations import a great deal. In 2008, the U.S. imported goods worth $820.8 billion more than it exported. As the goods corporations import get more expensive, their production costs go up. As cost pressures rise, corporations are more likely to pass on cost increases to you and I, the consumer. Moreover, if you are a shareholder in such a company, these cost pressures can have a marked effect on the company’s bottom line, negatively affecting the share price and your investment holdings. Clearly, the U.S. dollar can have large implications on corporate profitability and indirectly on you and your investments.
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* Source Bloomberg: On October 25, 2000, when the Euro was at its historic low, you needed U.S.$0.8272 to buy 1 Euro. On January 1, 2010, U.S. $1.4324 were needed to buy 1 Euro
What has caused the U.S. Dollar to fall?
When explaining the decline in the U.S. dollar we take a look at the big picture: we analyze large forces that have weighed on the markets, and in particular, have impacted the value of the U.S. dollar.
One of the major factors we focus on is the current account deficit. The current account balance is what the U.S. earns from other countries (exports, services, investments abroad) less what the U.S. pays to other countries (imports, services, loans). The size of this deficit has grown consistently over recent years and, in our opinion, was a key contributing factor to the U.S. dollar weakness. To put the present current account deficit into perspective, the net shortfall between what the U.S. earned and what the U.S. paid in 2010 was $470.9 billion. Another way to think of this deficit is that foreigners had to buy nearly $2 billion worth of U.S. dollar denominated assets every single business day just to keep the U.S. dollar from falling.
We consider the current account balance remains at unsustainable levels; long run, we believe considerable risks remain for the U.S. dollar. To read about our long-term economic views, please see our Economic Perspective.
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Why is gold the ultimate hard currency?
Relative to the supply of fiat currencies, the supply of gold cannot be readily influenced by central banks; therefore, we consider gold’s most attractive attribute is that it may retain its inherent value relative to fiat currencies. When a central bank “prints” money, whether this is through “quantitative easing”, “monetizing government debt” or any other term a central bank may wish to call such practices, it increases the supply of that currency. The additional currency value a central bank has printed can best be illustrated by the change in the relative size of that central banks balance sheet.
When there is an increase in the supply of one currency, with no offsetting increase in demand, the purchasing power of that currency is likely to decline. The more commonly used phrase for this phenomenon is “inflation”. In fact, many central banks worldwide (including the Fed) consider an inflation rate of approximately 2% per annum as reflective of “price stability”. To put such a “price stable” environment in perspective, under such a scenario, today’s $1 would only purchase 55 cents worth of goods in 30 years time. The supply of gold cannot be easily influenced the same way the supply of fiat currencies can. It is this attribute that we are attracted to, and why we consider gold to be the ultimate hard currency.
Is physical gold the only answer to protect against the ravages of inflation? Possibly, but even the staunchest gold bugs rarely ever invest all their net worth in gold, if for no other reason than it is impractical. The size of the gold market is much smaller than the currency market, and as a result, the price of gold tends to be more volatile. The principal motivation to invest in other currencies is to diversify based on concerns that the U.S. dollar’s purchasing power may not hold up and that – on a relative basis – it may hold up better in other currencies. We have long promoted baskets of currencies to mitigate the risks associated with the policies of any one country’s monetary policies.
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What is the impact of Chinese yuan appreciation?
The Chinese authorities have signaled their intention to allow the Chinese currency, the yuan or renminbi (CNY), greater exchange rate flexibility. Amongst others, we believe inflationary pressures have forced the Chinese authorities’ hand. In our opinion, currency appreciation would be an effective tool to help manage domestic inflationary pressures. So, what are the likely implications of a more flexible CNY exchange rate?
We believe currencies of nations exporting to China will benefit. On a net basis, with a stronger CNY, imports into China become cheaper; Chinese businesses and the Chinese government will be able to afford to purchase more foreign goods with a stronger currency, likely increasing Chinese demand for those foreign goods. Our analysis suggests the likely beneficiaries are those countries whose Chinese exports make up a substantial proportion of the exporting country’s overall GDP, as well as those nations who are experiencing solid, sustainable growth in exports to China. As such, currencies we believe well placed to benefit from a widening of the CNY trading band include the currencies of: Australia, New Zealand, Taiwan, Malaysia, South Korea, Singapore, and Japan.
We believe a stronger CNY may underpin Chinese demand for commodities and likely cause further commodity price inflation, when measured in USD. Furthermore, when faced with a stronger CNY, Chinese exporters have a choice of either lowering the price of their exports (sell their goods at the same USD level), or alternatively, try to pass on what is effectively a higher cost of doing business in the global markets. In our opinion, Chinese exporters are likely to pass on these increased costs. Our analysis shows that countries producing goods and services at the mid to high-end of the value chain have greater pricing power than those countries producing low-end goods and services. China, in our assessment, has long allowed its low-end industries to fail and migrate to other lower-cost producers within Asia. As a result, from a U.S. economic standpoint, we expect inflationary pressures to rise should the CNY strengthen.
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