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Deficit & Dollar Strength

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Deficit & Dollar Strength

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

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