Ten Points on the Global Economy: The Diminishing US Dollar

Back after a hiatus of sorts.  I should have a piece on my portfolio reshaping coming on Monday or so.  Tentatively, what I find fascinating, is that I have so many shoe and retail names near the top of my list.  Oh, and a few mortgage REITs, if they make sense… :(

But on with this morning’s topic, which deals with global macroeconomic pressures.  A few of the articles are a month dated, most are current, but this is meant to illustrate the pressures that the economy is under.

  1. Let’s start with the good news, ECRI still doesn’t see a recession on the horizon.  They’re pretty accurate, so I give them room, and mute my own views.
  2. That doesn’t mean there aren’t significant pockets of weakness.  Mortgage equity withdrawal is a spent factor, so to speak, and it ripples through current consumption and housing price weakness.  The less equity available, the less to pad consumption, and the less buying power for homes.  Credit card default rates are worsening, which can’t be good for buying power either.  On the low end of the income spectrum, many Hispanic workers are finding it hard, and that affects Wal-Mart, among other retailers on the low end.  That said, I have read that the Hispanic immigrants are much less likely to default on their mortgage loans than non-immigrants with similar credit characteristics.
  3. CLSA predicts a record gold run, and so far, gold is cooperating.  That said, it will take a lot more to get gold to $3400/ounce.  We would need a real dollar collapse, and not this slow grinding selloff.  That said, the grinding selloffs tend to persist; more on that later in this post.
  4. Of course, we could look at the price of wheat, or even just the price of stuff.  If it deals with food or energy, two items that are core to almost everyone’s budget, prices are rising.  John Wasik repeats a number of my arguments for why core CPI does not represent the diminution of the average person’s buying power.  I’m honestly surprised that no one has made a campaign issue out of honesty in inflation statistics so far.  It helped Reagan versus Carter in 1980.
  5. That said, maybe we should be grateful that fuel grade ethanol is in surplus, at least temporarily, because we can’t distribute it to the end consumers efficiently.  Maybe not.  It’s no good for price to go down, if it only indicates lack of effective end-demand.
  6. Oil at $90/barrel?  It’s partly a US dollar phenomenon (new trade-weighted low today), but not just a US dollar phenomenon.  In Euros, as I measure it, it’s a new high there as well, just not by much.   Now, when a critical commodity becomes scarce, it tends to attract wars, kidnapping, sabotage, etc., because bargaining power goes up as the price of the commodity goes up.  (Think of “blood diamonds” for another example…)  So we see pipeline sabotage, graspy politicians wanting a bigger cut of the royalties (no, not Chavez this time), and tensions between the Turks and the Kurds.  This leaves aside issues in Nigeria, and other aspects of supply disruption.
  7. Now if that’s not enough, Western oil companies, which are often shut out of places where goverment monopoly oil companies tread, are finding less oil, and find that they have to buy back stock because of a limited number of places to invest in new fields.  Now, perhaps OPEC has the same problem, but it manifests differently.  They’re making a lot of money also, and don’t want to plow it into too many new projects, for fear of killing the price.  So what do they do with the free cash flow?  Their governments buy US Treasuries and other US debt claims, closing the money loop and financing the US current account deficit.
  8. Well, maybe not entirely, though.  We had a glitch in capital flows in August, and foreigners sold more US securities than they bought by a significant margin.  Can’t help but think that it led to more pressure on the US dollar.  That said, the books have to balance: foreign capital inflows must balance the current account deficit over the intermediate term.  That doesn’t mean that they have to balance at the same price, though, just that the nominal values must balance at some implied exchange rate.  On the other hand, some nations are adjusting their currency baskets, like Vietnam and Qatar to reflect the lower value of the US dollar.  Quite a statement about their relative faith in their own currencies versus the US dollar.
  9. The US has not had a strong dollar policy for some time, despite protests to the contrary.  We are happier to see export industries prosper, US tourism prosper, and consumer buying power from abroad suffer.  My question is when we will see foreign governments notably uncomfortable.  We’re not there yet, which makes me think that the path for the US dollar is lower still.
  10. One final factor that doesn’t help: the size of the US budget deficit on an accrual basis.  Much larger than the stated deficit because of extra inflows to social security, and debt that doesn’t get counted because other government programs buy it to fund future liabilities.  Add onto that the wars which largely off-budget, and you have a significant present and future cash flow hole to cover.  Here’s to our children and grandchildren, who will have to pay it one way or another.


  • “and a few mortgage REITs, if they make sense…” Oh, come ON!

    You can’t be, on the one hand, a “value” investor who likes schlumping through the bargain basement of unloved stocks, and on the other hand, still be using macroecon to pick sectors or industries to stay away from. IMO, the essence of value investing is buying what everyone else is holding their noses at, and buying when the macro says to stay away from the play.

    Wait, the “on the other hand” comment reminded me of an actuary joke … I know you’ve heard it … besides, you’re the only actuary I know that I haven’t met in person, and those have all heard my actuary jokes …

    Re: core CPI, I’m surprised you’re repeating this argument against it. Listen, I’m not a defender of the CPI methodology (it’s lousy), and I believe that inflation is a monetary phenomenon that results in higher prices, but at least, despite my heresy, I have the decency to not mischaracterize the Fed’s argument re: core CPI. Their position is that today’s core CPI is a better predictor of future changes in the overall CPI than today’s overall CPI is, which is why they watch it. Now, whether or not their position is accurate, is a question of fact that can be answered, but I don’t think anybody at the Fed is saying that core CPI does a better job than overall CPI at measuring the past diminution of purchasing power, only that core is a better predictor of future changes. While the accuracy of the overall statistic is another issue, the whole “core vs. overall” is a straw man debate.

    Another flaw: while the U.S. dollar may have hit a trade-weighted new low based on the “major” currencies, those currencies don’t represent all U.S. trade. The “broad” index of trade-weighted has been far lower in the past.
    I covered this topic here:
    The “major” index accounts for only about HALF of U.S. trade. The true trade-weighted index is nowhere near a new low.

  • Steve Milos says:

    David, Bill:

    Fed Governor Mishkin is speaking today on the very topic of headline versus core inflation in guiding policy. Here’s a link to his speech:


  • Estragon says:


    Although you’re certainly correct in pointing out that the USD major currencies index is out of step with actual US trade, it’s also the case that many of the fastest growing trade relationships involve currencies which are fixed or otherwise managed. In particular, China and much of the Persian gulf region have fixed or crawling pegs to the USD. Although they have sovereign currencies, trade with them is effectively in USD. This tends to anchor the broad index at the older higher level.

    Also, the US dollar is clearly very weak in terms of financial flows, the majority of which are covered by the narrow index. As this weakness is apparently of no concern to policymakers, it seems likely to continue weak. As such, USD interest rates are low (or negative) in CAD/GBP/EUR terms, so we may see the USD become a carry trade funding currency.

  • China is the largest country (in terms of trade) not in the broad index. China is also the fastest-growing in terms of trade. In one year, the U.S. dollar has lost 5% versus it. In two years, lost 7.4%. Since the Yuan started floating barely over two years ago, the dollar has lost 9.3% against it. Is that a crawling peg, 5% a year or thereabouts? How much change is a crawl by your definition?

    The next largest non-broad countries are Mexico, South Korea, Taiwan, Brazil, and Malaysia. These five account for more trade than China does, and account for 1/5 of all trade in 2007. Which of these do you consider having fixed or crawling pegs, and by what definition?

    Persian Gulf nations are an inconsequential percentage of U.S. trade, based on the weights given by the Fed for 2007 and prior years.

    Enough people have mentioned the Persian Gulf region in my conversations about the dollar, that I am beginning to think it’s in some kind of “dollar bear talking points” memo. The key components are that (1) the fastest-growing are middle-eastern, and (2) most of the fastest-growing are managed. Both components of the argument are demonstrably false.

    Over the last five years, the fastest-growing relationships, in percentage terms, are in order: China, Venezuela, Chile, Russia, Saudi Arabia, India, Brazil, and Argentina, all growing over 10%. Israel has only grown 2/3 of one percent. No other non-broad nation has grown in trade over the last five years.

    Only ONE Persian Gulf nation in that list. Most are Latin American.

    The Bolivar and Riyal appear to be pegged from the 5yr chart, but the Chilean Peso, Rouble, Rupee, and Real are obviously not, based on the charts. I’d want to investigate the Argentine Peso to make sure. Regardless, at least four of the seven are unpegged.

    Most of the fastest-growing nations, in terms of trade with the U.S., do not peg the dollar.

  • Late edit: in “Over the last five years, the fastest-growing relationships” is referring to countries not in the broad index.

  • Josh Stern says:

    Re: “You can’t be, on the one hand, a “value” investor who likes schlumping through the bargain basement of unloved stocks, and on the other hand, still be using macroecon to pick sectors or industries to stay away from. IMO, the essence of value investing is buying what everyone else is holding their noses at, and buying when the macro says to stay away from the play.”

    IMO, value investors are just looking for stuff that has a higher expected return due to underpricing relative to one’s fundamental analysis. Contrarian investing is a form of sentiment analysis – if one had to divide everything into either fundamental based or money-flow based, contrarian strategies would be in the money-flow based category. In any given instance, value investing could be allied with or opposed to the contrarian take on a stock. Anyway, there is no reason for individuals to park themselves in style categories. But note that the spell check software on this blog seems allergic to ‘contrarian’. :)

  • Very often, a good company sells at a bargain price (a “value”) because of bad news. When that bad news is based on others’ interpretations of macroeconomics, and when the “value investor” professes a 3-year holding period, it is time to buy the “value.” The poor macro outlook is not a reason to avoid such a stock (given such proclivities and a long holding time) but is a reason why the stock is selling below its intrinsic value and therefore a reason to buy. Think of the “magic formula” and Joel Greenblatt – normalized P/E and ROIC, nothing else – do you think he’s loading up on stocks with “poor macro outlooks” right now? I think he’s probably buying more than a few.

    PS, Word doesn’t like “contrarian” either.

  • Josh Stern says:

    There are a lot of different reasons why one’s fundamental analysis can differ from “the market” or at least the current trading price. Thinking differently about the magnitude and/or direction of a macro factor is just one example which may or may not be part of one’s thesis. I’ve found that over the last few years, as often as not, the best values have been found in areas where the market’s published view is actually positive (e.g. because of country specific growth or commodity prices) but the stock prices haven’t moved enough yet to capture the financial import of the macro picture. Realistically, there is always some uncertainty about future earnings, so putting the macro effect on one’s side is a fundamental plus, other things being equal.