Welcome to the New Era of U.S. Dollar Dominance
For years now, I’ve argued at investment conferences with dollar bears who insisted that the greenback had nowhere to go but down.
They generally pointed to three primary reasons:
- The U.S. trade deficit
- Our sovereign debt
- The demise of the dollar as the world’s reserve currency.
Of course, you can talk until you’re red in the face, but facts and opinions don’t settle arguments like these.
So take a look at this chart:
Since bottoming in May 2014, the U.S. dollar is up 17.8% against a basket of world currencies.
The dollar bears weren’t just mistaken. They have been on the wrong side of a historic upturn in the currency, racking up massive losses for themselves and their followers.
Their pain and suffering is far from over, in my view. A dispassionate look at the facts demonstrates that we are in a new era of dollar dominance.
Let’s consider why the dollar bears have been so wrong, starting with the federal debt, a subject I’ve written about at length here before.
The national debt is inexcusable and poses a genuine risk to future growth. But it doesn’t pose an existential threat.
At least... not yet.
Debt - be it consumer, corporate or sovereign - becomes a serious problem only when the debtor can no longer service it.
That is not a threat today. Annual interest on the debt accounts for just 6.5% of all federal spending.
True, it will become a much larger percentage in the future. But with stronger economic growth, spending cuts, tax simplification and entitlement reform, there is still time to achieve fiscal sanity.
Meanwhile, don’t kid yourself that other Western democracies aren’t grappling with the same problem. No major industrialized country is balancing its budget or running a surplus.
Now let’s turn to the U.S. trade deficit. It totaled $405.2 billion in the first nine months of this year - and is on track to exceed the 2016 level.
This is not cause for alarm.
Unlike a household deficit, a trade deficit isn’t a debt that must be repaid.
And a trade deficit equals a capital surplus. When we buy steel, cars, jewelry and electronics from foreigners, those sellers get dollars in return. Many of them are put in dollar-denominated assets like U.S. stocks, bonds and real estate.
Much of this foreign capital goes to finance mortgages and consumer loans, helping to raise our standard of living.
When a country runs a trade deficit, it means the purchasing power of the currency is strong, and consumers are wealthy enough - and optimistic enough - to spend.
As the past week’s Black Friday and Cyber Monday sales numbers attest, Americans are opening their wallets. That’s positive for the dollar.
As for the greenback losing its status as the world’s reserve currency... that has always been a ridiculous fantasy.
The U.S. economy produces almost a quarter of the world’s annual wealth. Our country is the primary defender of the free world - and plays an extraordinary role in world leadership.
No other country attracts more students, more immigrants and more direct foreign investment.
What is the alternative to the dollar as a reserve currency?
Certainly not the euro, a political experiment between powerful, large countries and profligate, smaller ones that still threatens to come apart at the seams.
Not the yen, the currency of a country that has fought a debilitating two-decade fight with deflation and whose national debt as a percentage of GDP is more than twice as large as our own.
Not the yuan, the currency of a communist nation that doesn’t recognize even the most basic rights of its citizens.
And not the Swiss franc. Switzerland is a fine example of fiscal probity. But Pennsylvania has a larger economy.
That’s why foreigners continue to load up on U.S. dollars.
The commercial banks of Japan, Germany, France and Great Britain, for instance, now have more dollar-denominated liabilities than those in their own currencies.
And there are good reasons to believe the demand for dollars will only increase in the weeks ahead:
- The Fed is allowing $10 billion a month of its $4.5 trillion balance sheet - acquired under the bond-buying programs during the financial crisis - to roll off every month.
- The U.S. is stashing increasing amounts of cash at the central bank.
- The U.S. tax overhaul will motivate American companies to repatriate a large chunk of their cash stashed abroad.
A rising dollar, of course, is a good thing for Americans.
It helps keep inflation down, since imports become more competitively priced.
It holds down energy prices and undermines globally traded commodities. (That’s why the same analysts that were wrong about the dollar were also wrong about natural resource prices.)
It makes international travel less expensive for Americans, thanks to more favorable exchange rates.
And it drives capital flows our way and helps support U.S. stock and bond markets. (Foreign investors can look forward to appreciation in both the securities they own and the value of our currency against theirs.)
True, a firmer dollar makes U.S. exports more expensive in foreign markets.
But the trade-off of low inflation, greater purchasing power, cheap energy and rising asset prices is a decided plus.
So don’t short the greenback. Celebrate it.
We’re in a new era of dollar domination.
Thoughts on this article? Leave a comment below.