Today’s Myatt on Monday’s question was posed by a business school professor who asked: “Do you think we should be worried about the devaluation of the US Dollar?” While the short answer is yes, the reasons underlying the answer are both far reaching and complex. In today’s post I’ll not only give you my thinking on the US Dollar, but also its relationship to more macro economic concerns that left unchecked could give way to the potential for a US recession…
Let’s begin by examining the semi-recent history of the US Dollar (a very brief summary due to space requirements). Prior to World War II it was the British pound sterling which resembled the closest thing to a global standard for currency. The strength of the pound at that time was largely due to the fact that it was issued by an Empire upon which the sun never set. However the fact that neither the Empire nor the British economy survived the war intact gave rise to the growing strength of the US Dollar around the world. During the post war economy the US Dollar continued to grow in strength as the American economy became a worldwide juggernaut building a dominant trade surplus with most of the nations around the world.
While the US Dollar would ebb and flow in its strength over the years with events like the economic battle with the Soviet Union that was waged coterminously with the cold war, the United States declining oil production and resultant increasing dependency on oil imports, the evaporation of our trade surplus and mounting foreign deficit and finally the emergence of strong Asian and European economies, it was the establishment of a single European currency that was perhaps the final nail in the coffin.
Fast forward to last Friday when the US dollar traded down against 11 of the 16 major world currencies and at all time lows against the Euro and it becomes readily apparent to even the most casual observer that a seed change has taken place in the global currency markets. Perhaps most telling is that even the Canadian dollar is now worth more than the US dollar for the first time since the mid 70′s (That bargain Whistler ski vacation of years past just got a bit more expensive).
Certainly a major contributing factor to the US dollar’s devaluation last week was the Fed’s easing by cutting interests rates with an aggressive .50 basis point reduction. Along with recent capital infusions this was clearly another defensive move by the Fed to allay concerns over the credit crisis and the consensus opinion that commerce department’s release of home sales data later this week will show yet another decline. Furthermore many speculate the Fed may yet again ease interest rates by another .15 to .25 basis points when they meet again at the end of October.
While my crystal ball is certainly no better than anyone else’s I tend to look at the mounting economic data which depending upon how one connects the dots could certainly give credence to the possibility of a looming recession. Let’s take a look at just some of the data and I’ll let you draw your own conclusions:
- Mounting budget and trade deficits
- Historically weak US dollar
- A credit crisis that is just now beginning to rear its ugly head
- Waning consumer confidence
- The Fed’s aggressive economic policy in an attempt to engineer a soft landing
- August decline in the US non-agricultural employment index
Bottom line…the US dollar is no longer the default world standard currency and economic events of late certainly could be construed to paint a bleak economic picture which does not bode well for the US in general. That being said I am not a doomsdayer in my outlook. Just as markets cycle so do economies and there is a natural cleansing process that must occur to keep financial markets healthy and robust. Just as a stock market often takes a breather before moving onward, economies also have regular periods of expansion and contraction. We are clearly already in the midst of an economic slowdown, but whether it will lead to a recession is my opinion still to early to call. What I can say with a certain amount of confidence is that things are likely to get a bit worse before we see improvement.