USA Trade Deficit & Dollar Strength How trade deficits influence exchange rates By Esther van Luit
Alan Greenspan (former FED Chairman) “It seems persuasive that, given the size of the U.S. current account deficit, a diminished appetite for adding to dollar balances must occur at some point.“ (2004)
Paul Volcker (Former FED Chairman) “There is a 75% chance of a currency crisis in the United States within five years.” (2004)
The Dollar: an overview of 2004 & 2010 The dollar's value: exchange rates, Treasury bonds and the amount of dollars held by foreign countries. Top: 144 in 1985. Compare to 2010: 77.
Dollar strength measurements Exchange rates Treasury Bonds 2002 - 2008 - The dollar fell 40% as the U.S. debt grew 60%. In 2002, a euro was worth $0.87 vs $1.27 in August 2010. 2008 - The dollar strengthened 22% as businesses hoarded dollars during the credit crisis. 2009 - The dollar fell 20% thanks to fears about the $13 trillion U.S. debt. 2010 - The dollar rose 17% against the euro (Jan -June) due to the weakness of the EU's economy. Decline from August. High demand= low yield=strong Dollar Prior to 2008, the yield stayed in a range of 3.91% - 4.23%, indicating a stable dollar demand. 2008 - The yield dropped from 3.57% to 2.93% , indicating strong dollar demand. 2009 - The dollar weakened as the 10-year bond yield rose 52.6%, from 2.15% to 3.28%. 2010 - The dollar strengthened 22%, as the 10-year Treasury bond yield fell from 3.85% to 2.99%.
What determines the strength of a currency on the FOREX? Interest rates Inflation Terms of Trade Political stability & Economic performance Current Accounts Deficit National Debt
Interest rates Interest rates, inflation and exchange rates are highlycorrelated High interest ratesattractcapital, butalsocurbconsumerspending and borrowing.
Inflation Low inflationtypicallygoeswith a strongcurrency, sinceitperformsbetterthan high inflationcountries. The USA has a fairly low interest rate, especiallysince the last crisis
Terms of Trade, Political stability & Economic Performance Terms of trade = ratio comparing export prices to import prices. High terms of trade= high demandforcountry’s export goods…high demandforcurrency. USA: since 1960 deterioration. Terms of tradebecamestable in 2003. Relatively low. Stablecountriesattract money. The Dollar is the globalcurrency and thereforeattractive.
National debt (government) Accumulated U.S. National debt: $ 13,7 trillion Dollar Americans are adding$ 4.16 billion Dollar per day to the nationaldebt. National debt 2010=98% http://www.usdebtclock.org/
Total debt Total debt all U.S. sectors: $54.7 trillion, 296% of GDP. http://www.economist.com/blogs/newsbook/2010/08/government_and_private_debt_after_crisis Based on 2010 paper McKinsey Global Institute: Debt & Deleveraging: The global credit bubble and its economic consequences.
Current Accounts deficit The current account is the sum of the exports minus imports, net factor income and net transfer payments.Over-import = excessdemandforforeigncurrency. Thislowerscountry’s exchange rateuntillforeignersbuy. US Trade deficit grows in times of expansion. Recession has caused major shrinkage of the trade deficit. See 2008.
Per day:Americans spend $1.8 billion more dollars abroad than come into the country (2004)
Per year (2004):$ 660 billion = China’stotalimports 2005!!!
Conclusion 1 Politicalstability, economic performance, inflation, terms of trade and interest rates have remainedrelatively constant over the past years, in regard of the crisis. Therefore, the weakness of the Dollar must bedue to public debt & current account deficits. As theyincrease, Dollar weakens.
Funding of the debt USA is fundedbytrade-surplussers China, Japan and OPEC, and the UK (negative CA). China & Japan invest in TreasuryBonds to remaincompetitive. Both 20% UK = newcomer. x4 TreasuryBonds in 2009. 9% OPEC buysbonds to offset dollar devaluation orraiseoil-price. 5.5%
What’s to fear? An increase in Current Account deficits by Consumer abandons Dollar, switches to Euro Results in low demand for Dollar, USA will no longer be able to finance its imports, FED raises interest rates to attract capital and Dollar weakens even further. Chinese, Japanese, UK, OPEC stop buying Treasury Bonds Money no longer flows back to USA via bond purchases, FED needs to raise interest rates and Dollar weakens. 2009: China sells 180 billiononbonds. 2009: Japan faces 200% nationaldebt and may stop buyingbonds. UK already has negativecurrent account balance. OPEC stops raising oil price or switches to Euro Oil is priced in Dollars. As Dollar devaluates, OPEC raises price to stabilize their revenues. Venezuela and Iran both advocated in 2009 to switch to Euro.
The consequences of a weak Dollar Debtvaluedevaluates. Accusationbyforeigncreditors. USA becomes more competitive. Exports up. Oil prices up. Importsfor USA expensive, diminishconsumerspending & driving up the trade deficit in case of petroleum. Investors move out of Dollar reserves, sincevalue is declining. Terms of Tradedeteriorate. Inflation up, consumerspay the price. Ultimatelyslows USA Economy
Conclusion 2: Dollar collapses? NO Slow decline: Safe harborcurrency Global currency Oil currency Holders of US bondstradewith USA. Euro is not at truevalue Replacement by Euro? Euros held in reserves increased from $393 billion to $1.25 trillion in 2008-2010.
Will the Euro replace the Dollar as globalcurrency? In 2007, former FED Chairman Alan Greenspan argued that the Euro could replace the Dollar as a global currency. Central bankshold (2009) 27% Euro vs 62% Dollar Cross-bordertransactionsdone (2009) 40% in Euro vs 41% in Dollar EU = largesteconomy in the world (GDP PPP 15 trillion), but 2015/2016 China
Ben Bernanke (current FED Chairman) Thursday, November 4th 2010: QE2: The FED willbuyBondsfor $ 600 billion to speed up US economy and avoid the fate of Japan: a lost decade of economicprogress. QE1 failed (1.7 trillion, 2008)