As this year develops, the economy is stronger than it has been in a long time. Yet the process of spreading out the wealth and creating strong growth has yet to come together. While there is little doubt that our image of the economy is changing, some important things have not. The most important aspect of our economy, that it works for everyone with some degree of equity, is not changing much. That will keep our politics in turmoil for some time to come.
The reason for this is simple: the US Dollar is incredibly strong and is likely to remain so for years. This means that manufacturing, the life blood of the heartland, will not return soon. The anger over this, blaming China and Mexico and everything except the automation and accumulation of wealth which really drives it, will certainly continue.
The US Dollar is unique among world currencies in that it is the standard for world trade. Roughly 85% of all things exchanged around the world are priced in US Dollars regardless of where they come from or where they go. Iron from Brazil is paid for in China with Dollars, as is oil from Qatar to Europe. The world is always hungry for the Dollar.
Speaking of hunger, there’s a unique way to measure this.
Within each nation daily life goes on in some local currency. Economists have long desired a universal commodity which is the same around the world but created entirely at a local level from sources paid in the local currency. In 1986 such a standard was proposed by The Economist – the price of a Big Mac at MacDonald’s around the world. What once seemed like a joke has proven remarkably useful over time.
The current “Big Mac Index” is a way of comparing local currencies at purchasing power parity (PPP) to what the local currency can buy in world trade. Last calculated in January, it shows something very remarkable. Nearly every currency is undervalued against the US Dollar based on what it can buy at home. That is to say that in global trade, the US Dollar buys more than it reasonably should.
The Euro, for example, is a solid 20% undervalued by this measure. A glance at the price of the Euro since 2009 shows its decline:
Other currencies fare even worse. China is undervalued by 44%, meaning that everything in China is 44% cheaper than it should be to anyone with a pocketful of greenbacks. Mexico operates at a 55% discount.
This may seem like an incredible boon to the US, and it certainly is for travelers and entrepreneurs willing to go expat. But will it continue?
In order to answer this question, we need to know why it occurred. Remember that the US is unique among nations in that it essentially has no control over its own currency. Anything else, like say the Chinese Yuan Renminbi (the people’s currency,) goes up and down based on how many of them are circulating around the world. It’s easy for a nation to lower the price if its currency, and thus its manufactured goods or other exports, by printing more. That’s what we call a Currency War.
The US cannot do this.
Demand for the US Dollar, unlikely other currencies, goes with world trade. More trade among all the nations increases the need for Dollars. It’s up to us to provide a matching supply in order to keep the value from increasing.
Since we have started to move towards energy independence, the US balance of trade has only improved. It’s now running under $500B per year, which may seem like a lot – but it’s holding steady and even declining.
Compare that with world trade, which makes up about 26% of the world’s GDP. It’s growing at a rate of 3% per year, or holding steady as a share of the planet’s product. At about $80 trillion total product, $21 trillion is traded and it grows over $650 billion per year. Given that 85% of it is fueled by US Dollars, the demand is close to $600 billion more US Dollars every year.
We’re just not bleeding money fast enough in terms of how we pay for goods and services.
That’s not the only force on the US Dollar, however. Despite a Fed Funds rate famously near 0% for many years, US bonds have traded much higher for a long time. Consumers are more tied to this rate than anything set directly by the Fed. When the US economy appeared weak, just after 2009, the benchmark 10yr treasury traded much higher and only came down slowly. This can be taken as a measure of faith in the US economy.
What happened over the period of time from 2010 through 2016 is that money priced to support the US economy instead fled for opportunities elsewhere, most notably China. We’ve discussed this before in great detail and it’s worth understanding in depth. From a peak of 3.7% the 10yr Treasury slowly fell to 1.5% with no net change in Fed policy. This was nothing more than the cycle of US Dollars fleeing the nation and then repatriating as the economy came back – and we became the one true “Safe Haven”.
Money is fleeing China rapidly now, at a rate of $1.2 trillion in 2016. That may slow in coming years, but it is unlikely to stop. This is investment capital which is coming back, not the kind of ordinary expenses which immediately fuel jobs and winds up in the hands of working people. It’s money that will only make economic inequality worse.
Note that in 2017 it bounced up about 0.75%. That’s the rise in rates from the Federal Reserve, something which is likely to continue to go up through 2020 to 2.5% in total. That only makes Dollars harder to come by and puts more upward pressure on the Dollar, although in the short term it encouraged repatriation of that money over the last two years.
While there is a lot of money flowing around the US, there is less overseas. The value of the US Dollar can only go up with respect to other currencies given all this pressure on it.
The US uniquely has no control over its own currency around the world. The US Dollar is strong, meaning that factory workers in Ohio and other “swing states” are not getting new jobs anytime soon. The only hope they have is that investment comes their way, a slow process at best.
In the meantime the US Dollar can only remain strong.
Who will benefit from the global economy as we’ve come to know it? Sadly, it will be those who have benefited the most over the last eight years. Not much is likely to change for a long time to come. The US Dollar is strong and will certainly remain so, given our balance of trade and our status as the best safe harbor for money in the world. It will become known as a “secular” feature, meaning something which appears permanent although it is not.