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08/02/2007 12:00 am EST
August 2, 2007
The recent fear and trembling about the stock market, subprime mortgage loans, what have you, have diverted investors' attention from the bad-news bears' perennial whipping boy: the US dollar.
Just last week the greenback hit a record low against the euro, while the dollar index (which measures the dollar's performance against other currencies) is near its 25-year low, around 80.
The bears-who have been right about the greenback for the last few years-think it can go lower still, because of what they see as structural imbalances in the US economy.
But unless you believe that the US is in irreversible decline-which I don't-sooner or later the dollar will reverse course and head upward again. When that will happen is anybody's guess, but a stronger dollar isn't in the market right now.
And why should it be? The dollar is being squeezed by several short- and longer-term forces.
Right now, there's a gap between our economic performance and that of the rest of the world. While the world economy expands at nearly a 5% annual clip, the US is struggling to maintain gross domestic product growth of 3% a year. In the last couple of quarters it's fallen short of that, mostly because of weakness in housing and automobile sales.
Europe, long a laggard, has picked up steam. That has prompted the inflation-phobic European Central Bank to boost interest rates eight times over the 18 months to 4%. It will probably hike them again this fall. Meanwhile, the Bank of England, responding to higher growth, just raised rates to 5.75%.
But Federal Reserve chairman Ben Bernanke is standing pat, leaving federal funds at 5.25%. The housing bust and the subprime mortgage mess have made economic growth too tenuous and the US financial system too vulnerable to weather rate increases now.
Traders have played these discrepancies by selling the dollar or buying the euro, which is up nearly 10% against the greenback since last fall.
But the dollar has been weakening, in fits and starts, for the last generation. It has lost more than half its value from its peak in 1985, when the dollar index stood at 164.72. That September, finance officials of five nations met at the Plaza Hotel in New York and decided to drive the dollar's value down.
The problem then was the same one that's haunting us now: the huge US current account deficit. That's the difference between what we pay out to foreigners and what we take in from abroad. In 2006 that deficit was a whopping $811 billion, 6.1% of GDP. In 1991 the current account deficit was zero. It's been downhill ever since.
Interestingly, the dollar index hit low points in 1992 and rallied to another peak above 120 in mid-2001. Two huge events happened that year: the September 11 terrorist attack and China's admission to the World Trade Organization three months later.
The attack and its aftermath-the wars in Afghanistan and especially Iraq-have eroded the image of invincibility we had in the decade after the Cold War, contributing to the dollar's decline, in my view.
More directly, China's entrance into the WTO unleashed a flood of Chinese-made goods to our shores, causing a massive trade imbalance that made the current account deficit balloon. It has doubled since 2001, although rising oil prices haven't helped, either.
That has prompted traders to sell the dollar against the euro, which has gained about 40% against the greenback since late 2002. But China's currency, the remnimbi, has remained pretty stable, despite the nation's overwhelmingly favorable balance of trade.
Why? Because the Chinese government has, essentially, manipulated it. By keeping the remnimbi's value artificially low (it has agreed to revalue it piecemeal over time), Beijing has promoted the Chinese export boom and spurred the country's economic development at the expense of US-made goods. That's why the dollar has had to drop so much against other currencies that are not as tightly controlled.
So, what now? We may actually be able to reverse the current account deficit over the long run. Bernhard Graf, senior economist at Deutsche Bank in Frankfurt, expects the US savings rate to begin growing again and Asian consumers especially to begin spending more and saving less, reducing their vast surplus.
More intriguingly he thinks US exports will surge, especially in services, where he believes we have a real competitive advantage. "The US economy is the leader in new-economy services," he says. (You can read his report, "US Current Account Deficit-No Reason to Panic!," here. )
We may already be in the early stages of an export turnaround-spurred, of course, by a weaker dollar. "Through the first five months of the year, the US trade deficit ran about 3.4% lower than the same period in 2006," writes Louis Navellier in the August issue of Blue-Chip Growth. "On a yearly basis, exports have climbed almost three times faster than imports."
And it's hard to see how sentiment against the dollar could get any worse. Just last month, ResourceInvestor.com reported that traders "who trade large numbers of US dollar index futures contracts have been vigorously exiting what had been a considerable collective net long dollar position." The site dubbed it a "massive exodus out of long-dollar positions" even as the dollar dropped.
When the bulls start capitulating like this, can a reversal be far behind? "Contrarians have to wonder if this negativity is enough to trigger a move in the opposite direction," wrote Michael Kahn in his Getting Technical column in Barron's Online recently. "When 'everyone' thinks one way-bearish US dollar, in this case-then we have to think that 'everyone' has already acted on that thought."
Major changes in trade patterns, savings habits, and currency policy need to occur for the dollar to reverse its five-year slide, let alone its 25-year decline. A rebounding dollar would obviously hurt gold and the euro (in both of which I have small positions, via exchange-traded funds) and may take the wind out of the incipient blue-chip revival, which I have often discussed here.
But what goes up must go down, and vice versa. And the battered US dollar has fallen a long, long way. Comments? Please email us at TopProsTopPicks@InterShow.com.
Howard R. Gold is editor-in-chief of MoneyShow.com. The opinions expressed here are his alone and do not necessarily reflect the views of InterShow.
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