This article suggests that the Australian and Canadian dollars, and the British pound Sterling, can expect to decline significantly relative to the U.S. dollar in the months ahead and gold to decline even further relative to industrial commodity prices. Here’s why.
The above introductory comments are edited excerpts from an article* by Scott Grannis (scottgrannis.blogspot.ca) entitled The return of King Dollar.
Grannis goes on to say in further edited excerpts:
- Relative to its all-time high of May, 1985, when the economy was booming and the Fed was fighting inflation with sky-high interest rates, the dollar today is almost 30% weaker.
- Relative to the early 2000s, when the economy and equity markets were booming and the Fed was fighting the specter of rising inflation, the dollar today is about 20% weaker.
RBC Capital Markets]
U.S. Dollar’s Strength & Weakness Relative to 5 Major Currencies
The yen’s relentless appreciation over the previous 40 years made life very difficult for Japanese industry, for example, since they had to continually cut their costs to remain competitive with overseas manufactures. Now that the yen is closing in on its PPP value relative to the dollar, and the Abe administration is pursuing more growth-oriented fiscal policies, it’s become very good news for the Japanese economy and for the world.
Since the Australian economy is heavily dependent on commodity exports, the Aussie dollar has tended to move with commodity prices. It too peaked against the dollar in 2011, and since then it has dropped almost 20% relative to the U.S. dollar. By my calculations, the Aussie dollar is still about 40% “overvalued” against the U.S. dollar, making Australia a rather expensive vacation destination for U.S. tourists (and, by the same logic, the U.S. offers very inexpensive vacations for Australian tourists.)
The story is quite similar for the Canadian dollar, since Canada is also dependent on commodities, although not as much as Australia. I figure the “loonie” is still almost 20% “overvalued” against the U.S. dollar. As the chart above shows, Canadian inflation has been almost identical to U.S. inflation over the past 20 years, which makes it likely that eventually the “loonie” will weaken further against the U.S. dollar.
- fears that the Fed’s QE efforts would debase the dollar and lead to higher inflation;
- fears that trillion-dollar federal budget deficits would prove to be the norm and that in turn would lead to a significant rise in U.S. tax burdens;
- fears that an onerous increase in regulatory burdens under Obamacare and Dodd-Frank would weigh on the economy; and
- fears that the U.S. economy was vulnerable to a double-dip recession.
We’ve still got lots of problems to deal with (and the dollar is still weak), but we now know that:
- the Fed hasn’t (yet) made a big inflation mistake, and is on the verge of ending QE and beginning to normalize short-term interest rates,
- the federal budget deficit has fallen by two-thirds and is currently quite manageable,
- the debate over entitlement spending, which holds the key to the long-run budget outlook, is now centered around when and by how much spending can be cut, not whether. The ongoing failure of Obamacare and the long list of bureaucratic scandals in recent years have convinced a majority of the people that we suffer from too much, not too little government. Too much government killed Greece, and it’s killing Venezuela and Argentina as we speak and, finally,
- the U.S. economy has managed to grow by a relatively steady 2% pace for the past five years, and has been able to grow despite pronounced weakness in the Eurozone and a significant slowdown in the Chinese economy.
In short, things have turned out much better than the market feared. Looking ahead, it’s now pretty clear that:
- the Fed is going to pursue tighter monetary policy than the ECB, the BoE, and the BoJ,
- interest rate differentials are moving in favor of the U.S. dollar (i.e., U.S. short-term rates are rising relative to overseas rates) in anticipation of this,
- and that has also helped boost the U.S. dollar, as the chart below shows.
- a very uncompetitive tax system,
- a hugely burdensome regulatory environment, and
- an abysmally low labor force participation rate,
it’s doing better than most other countries. In short, things haven’t turned out nearly as bad as the market feared.
- U.S. investments look attractive relative to non-dollar investments.
- Commodity prices are likely to weaken further if the U.S. dollar continues to strengthen.
This is unlikely to be bad news for emerging market economies, however, because:
- the dollar will be strengthening, and
- interest rates will be rising, as the outlook for the U.S. economy improves. (A stronger dollar that results from overt and aggressive Fed tightening can be very bad news for emerging markets, since it presages a sharp slowdown in the U.S. economy—that was the case in the early 2000s. Every recession in the past 50 years has followed a period of very tight monetary policy, as evidenced by high real interest rates and a flat or inverted yield curve. We’re years away from that.)
Editor’s Note: The author’s views and conclusions in the above article are unaltered and no personal comments have been included to maintain the integrity of the original post. Furthermore, the views, conclusions and any recommendations offered in this article are not to be construed as an endorsement of such by the editor.
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