Promises, promises. How many ways can the politicians dream up to spend money that they don’t have? Perhaps it’s easy when you are the world’s reserve currency, and few argue with taking down IOUs denominated in US Dollars, at least for now.
But there are limits. When looking at the US Dollar today the markets have kind of a benchmark that they use as their default scenario:
- Fed funds will not drop below 1.5% at the bottom of this cycle.
- CPI inflation will not rise above 5% for this cycle.
- Nominal GDP growth will not drop below 4% for this cycle.
- The US current account deficit will improve, albeit fitfully.
- Total Federal Debt will not grow faster than $600 billion per year. (you didn’t know it was growing that fast, now did you? 😉 )
Of course, this is just my view, and I could be wrong. But the US Dollar has gotten trashed, and in order for it to get hit further, the powers that be will have to exceed the current “Limits of Irresponsibility.” As for the default scenario that I have laid out above, those are key parameters that I think are baked into the current low level of the US Dollar. Violate those levels, get a lower Dollar. Get further away from those levels, and dollar could rally.
When I gave my talk to the Society of Actuaries, one of my recurring themes was, “It is wonderful to be the world’s reserve currency.” Consider especially slide 32, where the weak dollar combined with strong overseas equity markets flattens out the net foreign assets to GDP ratio at near -20%. We ship our losses overseas, and that isn’t counting all of the subordinated structured product that they bought… yet.
I am not a doom-and-gloomer by nature. I try to recognize what is wrong, analyze what could be done to ameliorate the situation, and consider what could go right. I am not an optimist on the US Dollar, though I don’t see how it falls much further from here. There is room for the US Dollar to rally, if only a few things go less wrong.
In the long run, though, there are imbalances that the US needs to change, and the long run path of the Dollar will rely on those changes. I believe that the markets embed an improvement in US policies long run; if that fails, we will continue to see the Dollar deteriorate.