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The Amazing Dollar

Even if most people don’t believe it, the economy is certainly improving for some people. The Federal deficit has declined to $415B, or 3% of Gross Domestic Product (GDP), from a high of over 10% as recently as 2009. This has been fueled by a large increase in tax revenues combined with a drop in spending on unemployment insurance, mortgage assistance, and so on. Our trade deficit with other nations is also dropping rapidly due to lower imports of fuel, and now stands at less than $400B.

That’s good news all around. The only problem is that the US economy is borrowing money or sending it overseas at anywhere near the rate that the world needs it as trade expands. That is putting upward pressure on the US Dollar, meaning that while imports are likely to become cheaper there is little hope that US manufacturing is going to get a break anytime soon – despite remaining one of the big casualties of the depression so far.

Double-stacked containers

Double-stacked containers

In 2014 world trade is expected to grow at a rate of 5.8%, well ahead of the growth in world GDP. The world continues to move towards one big market and with what growth there is concentrated in developing markets the convergence between formerly independent markets is growing. We truly live in one big global economy.

As the $18.4T in world trade, or about 30% of world GDP, continues to expand we can expect an additional $1.07T this year. What remains special about that trade is that, by the latest estimates, 85% of it is still denoted in the global reserve currency, the US Dollar.

When China buys integrated circuits from Malaysia, it’s likely to be denoted in dollars. The same is true when Brazil sells oranges to South Africa or Europe buys oil from Dubai. There is still no currency that touches the world the way the Dollar does. Many are excited that China may realize its dreams of becoming a reserve currency, but even the head of their central bank has to admit that this is decades away. The world is stuck with the US Dollar, at least for now.

moneyGiven the increase in world trade, we can expect an increase of $906B in demand for dollars this year. But our trade deficit will send less than half that much overseas in 2014, meaning that demand is outstripping supply. The net result will be as it would be for any other market – the value of the Dollar will increase. That is already being felt so far this year as the Dollar continues to strengthen.

Demand for our debt is largely fueled by the same process. Treasury Bills (T-Bills), or the debt we issue to pay for our deficits, are so highly convertible worldwide that they are essentially the same as dollars – except that they bear some (small amount of) interest. Globally, central banks hold $3.72T in T-Bills, which is about 90 days of trade. It makes a cushion between changing currency prices as demand for Dollars changes in the market. If that was to increase at the same 5.8%, the demand for our debt should rise by $216B, or 52% of the debt we issue. But their holdings have typically run more on the order of 60% of the debt we issue, even back when we were borrowing like mad.

There can be little doubt that the austerity that we have promoted by the process of reducing our deficit so quickly has gotten far ahead of the market. The Dollar has to keep rising, which means that goods made in the US will continue to be comparatively more expensive.

What a "job" used to mean for many

What a “job” used to mean for many

Fed Chair Yellen has never spoken about the foreign exchange (or ForEx) implications of Federal Reserve policy. She has been very explicit that their focus is on employment here in the US. But if we are to grow manufacturing jobs, the Dollar has to stay as low as it possibly can. That suggests low interest rates should continue, since an increase in rates makes the Dollar more valuable still. If Yellen is watching manufacturing jobs in particular she would note that there are still 6M less of them than there were in 2008.  We know that there is no inflation, largely for this reason.

While the improvements in what were once called the “Twin Deficits”, our Federal deficit and the trade deficit, mean that we are no longer sending our wealth around the world there is no reason to believe that the world is not growing on its own without them. We may in fact not be printing Dollars quite fast enough to satisfy the demand for our greatest export, the greenback. This is a unique position that the US holds and looks to hold for the near term, no matter what happens.

The decline of the deficit and the pressure on the Dollar all point to this being the perfect time to relax and actually spend a little more, hopefully on our terrible infrastructure deficit. This is clearly not the time for austerity – even from a market perspective.

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16 thoughts on “The Amazing Dollar

  1. you mean that we were lied to about the greatness of austerity ? what a shock – the 99% suffering for the dogma of the 1% – screw good jobs they want their money to be worth more when the hide it in the caribean

  2. I understand that balancing the budget is unreasonable until we have a recovery. No matter what anyone says there hasn’t been one yet. But to say that that market needs us to run a deficit? That makes no sense.

    • It’s all because of the backward situation forced on us by being the world’s reserve currency. That gives us tremendous power, but only for those who can exercise it. Working people are at a disadvantage in this regime. That’s why I proposed a “Trade Weighted Exchange” some time back, a currency based on a basket of currencies that will wean us off of the role that is hurting us so much.

    • We’re still in the Postwar world in many ways, where the US dominates. That is ending, but not in an “end of an empire” way – more with a whimper.

  3. The reason the dollar is up is because the world is not down with China and Russia.

    BRICS have run into a brick wall.

    • China is still chugging along, but they are definitely going to hit the wall soon, if I believe what I read. I think Russia has already really screwed itself over Ukraine. The BRICS are certainly not what they seemed.

  4. Now it is not your argument, since you are much too nuanced for it.

    I did want to disabuse the gentle readers of simultaneously being concerned that fed prints too much money and doesn’t print enough money.

    • It all depends how you look at it. C’mon, you’re an economist – isn’t there always, “On the other hand …” ? 🙂

      Seriously, I have been wondering why with all this printing there isn’t inflation. It took some digging, but I found at least one answer. It seems like a good one. But it does make me wonder how long it’ll last.

  5. Yes there is the weighing of the policy option against the benefits and advantages of not doing it or doing the opposite policy.

    But when it comes to reading your blog, we don’t want you to be both an ardent capitalist and an ardent social democrat. We don’t want to see you twist yourself into rather awkward opinions. It is too hard to watch…it’s like when trains used to crash into each other head on in a different era. ; )

    • I’m working on an honorary PhD in economics, so I have to contradict myself periodically. 🙂

      Seriously, I’m not really a Social Democrat, I’m an American Democrat. I believe in the free market first – except when there’s an obvious market failure. I do believe that the system we work under is not pure capitalism, or the rule of money, but based on an ideal called a “Free Market” – which is defined socially and legally as much as it is economically.
      So if I seem harshly negative, it’s a reflection of what I see as a need for more regulation to open up access to the market. Perhaps I should be more explicit about that in the future to be (or at least sound) more consistent.

    • Only the US Dollar, as the global reserve currency, has this problem. As global trade increases, 85% in US Dollars, we lose more and more control over our currency every day. The power that it brings us (read: those with a lot of Dollars) is intoxicating, but it has a price.

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