A famous maxim has it that in the short run markets are voting machines, but in the longer run weighing machines. The point is that though short run movements can be remarkably fickle and irrational, markets do – eventually – self-correct and produce reasonable prices. But “eventually” can be a long time, especially where currency markets are concerned. A notorious example was in the early 1980s when for nearly four years the U.S. dollar became ever more overvalued against the Japanese yen and the Deutsche Mark. The correction, when it came, was massive – nearly 50 percent against the yen – but in the meantime a lot of people had learned the hard way that shorting is not for the faint-hearted.
Yet although currency forecasting is a hazardous business, I am going to tempt fate today by suggesting that the dollar is close to a secular high. Since the summer of 2012 it has risen more than 50 percent against the Japanese yen and since the spring of 2011 more than 30 percent against the euro. Such strength makes no sense given that a currency’s long-run prospects depend largely on the underlying strength of a nation’s trade (and the relevant nation in the case of the euro is of course Germany, not Greece).
Although the U.S. press virtually never reports the trade figures these days (except on the rare occasions when they seem to be improving), the fact is that imports of manufactured goods have continued a rising trend that has persisted for most of the last fifty years. The only thing that has staved off total catastrophe has been the rise of fracking. Now fracking has been hit by a double whammy. Most obviously lower oil prices have rendered many prospective fracking projects uneconomic. But even had oil prices remained high, fracking was never a long-term proposition. The fact is that, for engineering reasons, fracking production from any particular well peaks early and declines fast.
Even with the full benefits of peak fracking and peak oil prices last year, America’s current account deficit was $361 billion. Germany meanwhile ran a current account surplus of $257 billion, China $183 billion, and Japan $56 billion.
The outlook for the dollar is not improved by the fact that overseas-based portfolio investors are looking more critically at U.S. investment assets.
The worst part of it is that the United States no longer has the means to get its trade back into balance. In former times a current account deficit could be eliminated simply and quickly by devaluing the dollar. This was what President Richard Nixon did in 1971, and in less than two years U.S. trade was strongly back in the black. Now that most of America’s manufacturing industry has moved offshore, however, a devaluation would actually on balance severely worsen the trade deficit because the dollar cost of many U.S. imports would soar. Meanwhile as America these days depends heavily on commodities for its exports and these are denominated in dollars, a devaluation would do little to boost America’s export receipts.
Postscript: Having peaked a few days earlier at 0.9524 euros, the dollar closed on March 20 at 0.9444. Against the yen, it closed at 121.10, down from 121.44 on March 14.