Paul Stafford on the Dollar
Hello everyone. Thanks to Kris for allowing me to share my fundamentals views on a weekly basis. I thought it might be interesting to think about the dollar and where it’s going long term. As it is the basis or counter currency for most FX volume, it behooves us to have a good handle on that.
Since almost everything we look at is valued in dollars, it is sometimes hard to separate the effects of a strong or weak dollar from real economic trends. For example, gold is hitting record levels vs. the $, and oil may finally punch through the $73 level. Are these real effects? Well, one interesting measure is the Gold/Oil ratio. Historically, it has hovered between 10 and 15. In February of 2009, it rose to nearly 30. Now it is back to about 14.7, or well within its historical range. If you look at gold vs. other currencies, it is not at historic highs- for example it remains 30% below its highs in AUD. In actuality, demand for commodities is still very low. Witness the “ghost fleet” of 500 freighters (20% of the fleet size) idled off Singapore due to lack of international shipping, or the Baltic Dry Index, etc. High commodities prices are simply the result of a weak dollar.
The S&P is now trading at a massive 27:1 trailing P/E ratio, and 140x trailing P/E on reported earnings. This is three times the levels of the tech bubble. I believe one reason (amongst others) is the depreciation of the dollar. Another direct indication is the $ index, now at 76 (nearly its 10 yr low of 72 in July of 08), and a far cry from its highs over 117.
We must ask- is this a low from which the $ stages a comeback, or just the beginning of a long term slide? I fear I must come down on the side of further depreciation over the long term.
- USA budget deficits will inevitably worsen due to lack of political will
- The inexorable move away from the $ as the reserve currency due to its mismanagement. This has already started (China, oil producers)
- Implicit monetary policy- the Fed will not move strongly against inflationary pressures
- Carry trade effects as other countries exit QE and raise interest rates earlier ($ becomes a funding currency)
- Sentiment- when markets lose confidence in a currency (witness the Pound when it withdrew from the ERM), sharp declines and high volatility will dominate
I always try to look for disconfirming evidence, and one positive element for the dollar might be an improvement in the current account deficit due to a weaker dollar driving exports. However, the continued offshoring of manufacturing, and import of energy argue against this having a large net positive effect.
This doesn’t mean that the dollar index will drop monotonically in the next 6 months or year. Exogenous events, black swans (think Iran and nuclear missiles aimed at Europe) can all reverse direction for many months. After all, the $ index reversed its decade-long decline from 117 to 72 back to 89 in only 4 months as risk aversion set in, in late 2008. But the future cannot belong to the dollar.
Paul Stafford is an accomplished investor, business expert, and trader. He performs practical fundamental currency market analysis in his weekly “Stafford Weekly Currency Briefing” at 4xtradertools.com
