The DollarOctober 10, 2014
Stronger than expected reports [last] Friday on payroll employment and the trade deficit reversed a run of weaker data on ISM, car sales and construction spending earlier in the week. This left the consensus on the US economy roughly where we left it last week – between 3 percent and 3.5 percent for the third quarter and closer to 3 percent for the fourth quarter. Meanwhile, data from overseas was almost unambiguously softer, exacerbating the spread between economic performance in the US and abroad. European Central Bank President Draghi provided less detail than expected on the upcoming quantitative easing, reinforcing the Euro Zone’s concern about deflation and weak growth. Meanwhile, China unexpectedly loosened the downpayment requirements for a second and third home, in a concession that the weakness in the housing market is wearing on the economy. Three Federal Reserve Bank Presidents mentioned the stronger dollar in observations on the future of monetary policy – though the dollar remains the purview of the Treasury. Bottom line, the dollar induced decline in commodities prices is clearly a non-inflationary boost to US growth – acting like a tax cut.
It is the function of the market to strengthen the dollar and shift growth that was occurring in the US to weaker foreign competitors. While a strong dollar allows US firms to buy the best from overseas – whether companies, labor, or goods and services – it also hurts US sales, especially in our strongest industries. US growth (and the trade deficit) has benefited primarily from a renaissance in energy production and our comparative advantage in technology, which is embedded in capital goods exports. Dollar denominated commodities naturally decline in price as they become more expensive to foreigners. Domestic shale oil is a high cost source of production, so its profit margins will suffer the largest decline limiting future expansion as energy becomes available from sources with cheaper production costs – like Russia where the ruble is collapsing. US technology oriented capital goods (and US services) are primarily domestically produced, so their cost to foreigners will rise more than products with higher import content, like automobiles and aircraft. Other largely domestic industries, like housing and health care, will face increased competition for the consumer dollar from cheaper imports, like automobiles, furniture and furnishings and apparel & footwear. US labor also becomes relatively more expensive, encouraging firms to import productivity enhancing equipment. We recently visited a plant in Shenyang, China where sophisticated robotic arms with applications from automobiles to food processing were produced entirely by hand by low wage workers. There were no robots – not even their own – in the robotics factory. This is the type of competition the US faces as the dollar strengthens.
The decline in the dollar is both a boon and a bane for the rest of the world. A boon obviously as it reduces competition from the US and a bane in that it tightens global liquidity. The dollar is the reserve currency and main denomination for international loans, which just became more expensive. However, for some nations with substantial investments in the US, like Japan, the stronger dollar lifts household wealth augmenting spending power. This is not true in China where the yuan is strengthening against the dollar. The advantage of less US competition is not great as the US runs a trade deficit. And, the reality for many countries is that most currencies have been depreciating against the dollar, so there is little improvement between countries – like Japan relative to Germany.
The preceding is an abridged version of a commentary for McVean Trading and Investments, LLC and has been reposted here with permission of the author.
The ideas and opinions expressed in this blog are those of the author, and they should not be perceived as investment advice or as any other kind of advice.