Wednesday, September 29, 2010

U.S. Dollar To Depreciate Further

Confirming that it is a race to the bottom for major currencies, Simon Johnson, a professor at MIT’s Sloan School of Management and co-author of  “13 Bankers: The Wall Street Takeover and the Next Financial Meltdown,” says the US dollar is likely to depreciate further.

The trouble with this is that all major currencies need the same treatment, therefore, who will they depreciate against? Gold is a  very small market in comparison and it has been many decades since these currencies were backed by gold. In addition, gold market is easily manipulated.

We track all currency ETFs live here.

This leaves emerging market currencies, which is exactly what Johnson's mentions in an opinion article. He argues, some of these economies are booming again, certainly the case of Brazil for example, and they do not have the firepower to contain an appreciation of their currency.

Johnson says the U.S. can recover quickly, and jobs can come back much faster than expected, but only if the dollar now depreciates.

He states that significant dollar depreciation is more probable than most now suppose.

"The main reason the U.S. isn’t bouncing back so fast is because of exports and the dollar. South Korea, Russia, and other emerging markets that go through severe crises usually undergo a sharp depreciation in the inflation-adjusted value of the currency, making them hypercompetitive, at least for a while. This makes it easier to replace imports with domestic goods and services and much more attractive to export.

In contrast, the global financial crisis actually strengthened the U.S. dollar as it was seen as a haven, although the dollar has fallen somewhat from its recent peak against major trading partners".

And that is a little problem with this theory as the crisis in Europe can trigger another run for the USD at any moment.

SJ: "It takes time for a big economy like the U.S. to export its way back to growth; exports were only 12 percent and 13 percent of gross domestic product in 2007 and 2008, respectively, while imports were 17 percent and 18 percent of GDP.

Yet the logic of today’s economy is pushing the dollar down and exports up and, in turn, aiding the businesses that compete against imports. There are three forces at work.

[...] with unemployment obstinately high and fiscal policy on ice, the Federal Reserve will continue to push down long-term interest rates. Further rounds of quantitative easing will tend to weaken the dollar. This is a much more effective way to move our currency than any foreign-exchange market intervention even though the Fed will tell you that it really doesn’t care about the dollar.

[...] emerging-market economies are already booming again and demanding the kinds of upscale goods and services that the U.S. is capable of exporting. These emerging markets would like to resist currency appreciation; they prefer to keep their current accounts in surplus, following the Chinese model. This may work for a while, but in this case they will accumulate even more foreign-exchange holdings and, given the stance of U.S. policies, these governments will surely diversify more of their reserves out of dollars".
"The dollar is, therefore, likely to depreciate against all floating currencies. If this happens, the impact on U.S. interest rates will be minimal because the Fed will continue its easing. Inflation may rise slightly but high unemployment means the impact will be small, perhaps not even to the 2 percent annual rate that modern central banks quietly prefer".

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