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Thank you for visiting our research currency opinion on the United States dollar (USD). Below, we have highlighted currency issues that we think the Internet reader may find intriguing. If you are interested in a detailed analysis, please contact us here at BankINTRO.com.
The United States compared to other individual sovereign nations is the most powerful and technologically advanced economy in the world today with a size in excess of 13 trillion USD. The U.S. economy is successfully moving into an information and knowledge-based economy (recent examples include the launch of a popular web site Facebook.com). Investors for years have viewed America with much political stability, economic freedom, progressive corporate laws and regulation, economic and military strength which has helped to foster foreign direct investment into the United States.
Will the United States continue to dominate into the 21st century as the only economic and military superpower? China will rise to be the world’s next great superpower along with a revitalized Russian economy and a renewed emphasis for increase defense spending within Japan.
The USD will remain a reserve currency for the world. In addition, several countries around the world today use the USD as their national currency ‘dollarization’ or de facto currency via currency boards. The world of money is moving towards regional currency blocs. New competing reserve currencies will include the Euroland euro (EUR), gold bullion, Japanese yen (JPY) and the Chinese renminbi (CNY) when it goes convertible in the years ahead.
POLITICS: Democrat / Republican USD cycles
Since the USD was floated in 1971 after the USD severed its ties to gold under former U.S. President Nixon, it is interesting to note there has been relatively consistent USD strong / weak currency valuation cycles of 6 to 9 years following a somewhat political bent. From 1972-78, the USD was in a weak cycle under mostly Republican tenure. During the time of President Carter and the Democrats, inflation soared as did interest rates. The USD entered a bull market from 1979-85. Again mostly under Republican power of former President Reagan and President Bush 41, the USD fell into a weak cycle from 1986-95 culminating in the ‘Louvre Agreement’ in 1987 when America’s trading partners came together to support the then very weak USD. Following a consistent trend again, under Democratic President Clinton, the USD entered a strong bull market 1996-01. Since year 2002, the USD has been in a freefall under President Bush 43. What is this to suggest? Our best currency guess based on Democrat / Republican influences on the USD is to expect a cyclical bull market in the USD likely around year 2009. However, currency caution for the USD is in order depending on how protectionist a possible Democratic regime / Congress maybe as changes to free trade agreements / protectionist policies may curtail U.S. manufacturing exports of which are presently on a significant rebound.
Final note, when top finance officials in the White House are from Wall Street, this tends to bullish for the USD as they are concerned more about the bond market. Conversely, when a senior finance official comes from Texas, this has tended to be bearish for the USD as they wish for a lower USD to stimulate commodity exports.
America will remain a stable prosperous country – the world’s only superpower primarily due to its very stable democracy. Please contact BankINTRO.com for further details on America’s political analysis.
ECONOMICS: recession / mild depression ahead in short term? An asset liquidation phase as malinvestments in the U.S. real estate market gets corrected over the next 2 to 3 years during a period of slow economic growth. This downturn will be more severe than the mild 2001 recession, deflation pressures in real estate and in equities is presently in progress. There will be continued inflationary pressures in energy, agriculture – food, etc in the near term but this trend may reverse in say two years. The short term is indeed a difficult scenario for the poor / middle class of America for those on modest incomes.
Significant economic strain to the U.S. economy is attributed to high world USD oil prices. In our view, we think the oil price may have peaked at around 100 USD/barrel. It is quite feasible that oil will retrace back towards 65 USD/barrel. Further, the world oil market may soon be awash in oil if Iraq is able to ramp up production significantly by year 2011, Iraq is sitting on one of the world’s largest oil reserves. Other significant new petroleum sources include Canada with the tar sands, Venezuela with offshore shale deposits, Western United States with vast shale deposits, Russia with its vast reserves, etc. A lower oil price is bullish for the USD as this will help to reduce the U.S. current account deficit. A stronger USD will also help to bring USD oil prices even lower due to exchange valuation alone.
Total GDP stands at 13 trillion USD (2006) with corresponding GDP/Capita at 43,500 USD. GDP growth for 2006 came in at 2.9 percent, year 2007 at 1.9 percent. The trade deficit for year 2006 at 838 billion USD. Public debt at 69 percent of GDP, external debt at 10 trillion USD (2006). For comparison, Japan public debts stands at 140 percent of GDP. Official unemployment came in at 5 percent (January 2008) and is forecasted to rise in the near term.
Interest Rate Differentials
The drastic cut in U.S. short term interest rates during 2001 to an ultimate low of 1.25 percent resulted in a housing and credit bubbles as analysts felt that rates were kept too low for too long. At present, the US Fed rate stands at 3 percent (January 30, 2008) and is likely to continue to decline further in the near term. UK rates are at 5.5 percent (likely to be cut to 5.25% in February 2008 and fall to a projected low of 4.50 percent by year-end 2008). Eurozone rates presently stand at 4 percent and are likely to fall later in 2008-09. So in the short-term, U.S. and Eurozone rate interest rates are set to widen than narrow in 2009.
Historically, lower U.S. interest rates tended to be bearish for the USD. A new thinking today may not prove this out as some analysts believe lower American interest rates may actually stimulate U.S. GDP growth rates and be more bullish for the USD whereas higher Eurozone rates may mitigate their GDP growth rate. So, the old theories may not apply particularly now as the market has already discounted further interest rate cuts for America into current USD pricing. Of interest, the multi decade long term average U.S. Federal Reserve rate stands at 5.25 percent. From years 2000-06, the rate averaged 1.93 percent.
Some analysts are projecting a 25 percent decline in U.S. home values from the former bubble valuation that peaked in 2005-06. There is a significant supply/demand imbalance with a projected 15 million unsold homes in inventory, this may take a few years to clear. A slowdown in housing will increase the savings rate. In the commercial real estate market, a slowdown appears to be in progress.
The U.S. Fed stopped reporting M3 in March 2006, some analysts believe that the inflation rate is higher than advertised. Money supply growth is unofficially estimated at 16 percent annually. Year 2007 annual official inflation reported at 4.1 percent. Current Federal Reserve Chairman Bernanke does favor inflation targeting. It should be mentioned that two-thirds of U.S. banknotes circulate outside the United States. Deflation risk threat has now increased for the United States, deflation will result in an increase in bankruptcies, a forced asset liquidation.
Current Account Deficit
The current account shortfall does not completely convey an accurate macro economic picture. It is estimated that upwards of 40 percent of the deficit is internal trading by U.S. corporations and their respective divisions with operations abroad. The CA deficit is now on a narrow decline. America’s CA shortfall will be corrected mainly by an increase in the U.S. savings rate via lower consumption which is likely to result in a recession. A lower USD entirely will not be able to correct the current account deficit. The current account deficit came in at a stunning 811.5 billion equivalent to 6.25 percent of GDP for year 2006 and is running at around 793 billion shortfall for 2007.
Each 10 percent drop in the USD versus a trade-weighted currency basket will result in a 1 percent drop in the current account deficit. A CA deficit of say 2 to 3 percent is manageable providing the GDP growth is at 3 percent or more and America’s net assets increase greater than CA shortfall. It is an increase in the U.S. savings rate that will have the greatest impact on narrowing the U.S. current account deficit, not USD depreciation. The U.S. current account deficit will also further narrow as the Chinese renminbi (China has one of the largest surplus accounts with the United States) appreciates to say 6 CNY to the USD in the medium term.
US Budget Deficit
The fiscal deficit for 2007 was a respectable 1.2 percent of GDP or 162 billion USD shortfall. However, the projection for 2008 is significantly weaker due to the U.S. economic slowdown and the cost to finance an economic relief stimulus package. The fiscal deficit is forecasted at 410 billion USD or 2.9 percent of GDP for 2008 and year 2009 at around 400 billion USD. The U.S. Social Security is a very generous payout system when compared to other countries’, this program in time will be revamped to reduce contingent liabilities. BankINTRO.com forecasts America will follow the rest of the industrialized world and implement consumption taxes similar to Canada’s GST (Good’s and Services Tax). Bonanza tax revenues will be redirected to America’s crumbling infrastructure, trillions will be spent on rehabilitating bridges, roads, schools, upgrading air traffic control, etc. This will be one of the next big economic booms for the United States: massive infrastructure and monies directed to new green economy investments.
It appears that an asset liquidation is on the way – the bursting of the U.S. housing and commercial real estate markets, corporate bond market downgrades, derivatives, etc.. High household debt has historically resulted in financial difficulties. Of significant concern are recent challenges amongst America’s big bond insurers, MBIA and Ambac. Both corporations lend their top credit rating to lower grade debt, however, both bond insurers are having troubles and may have their own rating downgraded. In fact, Fitch announced that they have dropped their rating for Ambac from ‘AAA’ to ‘AA’, this will further create liquidity difficulties in corporate America.
POSITIVES: impressive diversified economy, military power, knowledge-based economy is growing, flexible labor market. CONCERN: oil-exporting countries have reinvested their gains from higher oil prices in year 1999 - 2007 into USD assets. Will this trend continue? Majority of American’s have very low net liquid assets with 54 percent of the population having less than $5,000 saved for retirement.
ECONOMIC SOLUTION: the United States must transform from a ‘borrow & spend’ nation to ‘save & invest’ to correct the current account deficit. In order to solve its fiscal deficit, America should implement a consumption tax similar to Canada and Europe. This tax is a windfall due to its reach and ability to tax those who cheat the system including the massive drug trade, underground economy, etc. Further, income tax levels should be lowered in due course reflecting the large consumption tax revenues garnered.
BANKING SYSTEM: increased volatility, more vulnerable, sub-prime issues.
Inflation or deflation fears ahead? Offshore Sovereign Wealth Funds (SWF) majority backed in the Middle East and Asia are investing into the U.S. banking system in the likes of U.S. financial giants Merrill Lynch, Citigroup, etc. U.S. bank mergers are good for system stability. Fallout out from sub-prime mortgages: not solely a U.S. banking system problem, the risk is spread worldwide with European & Asian banks and others holding the bag.
At present, the U.S. banking system is one of the world’s soundest, but vulnerabilities lie ahead. U.S. banking system has been taking on more risk to generate higher returns demanded by shareholders. But risks remain as noticed with Citigroup reporting record losses and seeking investors from abroad to shore up its capital base The existence of derivatives throughout the U.S. financial system is a viable threat to many U.S. banks. At various times in American history, there have been mass banking system failures: 1929-30’s depression where approximately half the banks failed, the Savings & Loans crisis in the 1980’s. At other times, panics in the U.S. banking system took place in 1873, 1884, 1890, 1893, 1896, 1914, and in New York State in 1907. Today, U.S. bank failures for the most part are very rare. America’s official reserve assets stand at 71.425 billion USD (January 11, 2008).
Central Bank Reserves Allocation.
Surprisingly to many, recent central bank diversification is slowing due to the current pricey euro (EUR). It is now the wrong time for central bankers to convert from USD to EUR – bullish for USD at tail end of EUR currency cycle. USD today remains for the most part the reserve currency of the world with a great many country central banks holding USD reserves. Total reserves as of December 2006 at 4.8 trillion USD equivalent. Foreign central banks as of QTR3 2007 held 63.8 percent of their reserves in US-dollars, the size of the euro position at 26.4 percent.
The fear for the USD is a run or panic to be partly fueled by central banks dumping US-dollars for diversification purposes plus the view that the USD will decline further in value. There has been some reserve allocation over the last few years from USD into other currencies, but the majority of this seems to be over. Why? With globalization, the large world economies are becoming more integrated. If China decided to dump USD, they would hurt the stability of their own economy and devalue their investment holdings of US-dollars. This view may change in 20 years or so as by then China will not have to rely on exports for wealth but rather their new own large domestic consumer based economy – cycle of economic maturity for China.
The talk of USD doom with the Chinese et al to begin dumping dollars en masse is very unlikely. More likely scenario is for China and others to invest in U.S. and other Western corporations via SWF’s (Sovereign Wealth Funds). BankINTRO.com does not see a run on the USD via central bank holdings, only modest realignments in reserve holdings with further increases into gold bullion, Japanese yen, British pound and Euroland euros. China in an ironic way is tied into the dollar zone economy so they will recycle their US-dollars back into the much larger American economy as an investor.
KNOWLEDGE: Amero in the future?
Yes, absolutely. The new concept currency of the amero will replace the Canadian dollar, US-dollar and Mexican peso to form a new North American monetary union. Such a currency framework is likely 20 years out. Please read our currency review on the ‘AMERO’ within this BankINTRO.com currency index.
CURRENCY: ISO Symbol ‘USD’, US-dollar, dollar. At time of review on February 4, 2008 the US-dollar had an exchange valuation of 902 USD (New York last) to one ounce of gold and/or 1.4832 USD to the Euroland euro (EUR). Exchange rate regime follows that of a free float. Today, many countries use the USD as their currency (‘dollarization’) and/or as a peg for their own national currency. The USD is the unit for which most of the world’s assets and liabilities are denominated in – global reserve currency. The USD is fiat money, that is, the market determines the value based upon the level of strength and confidence investors view the United States economy. The USD is no longer backed by gold although it is presently pegged by 21 other national currencies. As measured in purchasing power parity, the Japanese yen (JPY) is 16 percent overvalued to the USD, the Euroland euro (EUR) is 25 percent overvalued to the USD and the Canadian dollar (CAD) is 22 percent overvalued. As of December 2007, the USD was at its lowest valuation since 1980.
USD Valuation to the Euroland euro (EUR)
When the euro came into circulation in January 1999, the euro traded as high as 1.17 USD to the EUR. Shortly thereafter, the American dot com high tech boom created enhanced capital inflows to American stock markets, appreciating the USD to 82.52 US cents to the EUR by October 26, 2000. Now at 1.48 USD to the EUR range (recent record low at 1.4966 USD), the USD may fall to 1.5 to 1.55 USD to the EUR, but ultimately our forecast at BankINTRO.com has the true USD trading range closer to 1.1 to 1.2 USD to the EUR. The USD overshot its natural euro trading level by several standard deviations on the upside back at the height of the US technology equity stock boom in 2000 - 2001. Conversely, at 1.4 to 1.5 USD to the EUR, the USD is currently at the bottom end of its long term stable trading valuation for the USD relative to the EUR. This is consistent with historical trading patterns as the USD has had a wide trading range with the former German Deutschemark currency. In 1995, the USD traded at a record low to the Deutschemark at an equivalent valuation of 1.45 EUR.
CURRENCY HISTORY: historically, the USD has been a stable, a ‘hard currency’. The United States has only had one currency in use since its founding, the ‘US-dollar’. Although during the U.S. civil war, the Confederacy’s money experienced a massive depreciation and was not a factor versus the USD. Historical exchange quotes include year: August 2007 at 1.361 USD to 1 EUR, December 2006 at 1.32, April 2005 at 1.294, April 2004 at 1.198, May 7, 2003 at 1.138, January 1, 2003 at 1.043, July 17, 2002 at par, February 27, 2002 at 0.8669, November 21, 2001 at 0.8789, September 12, 2001 (day after New York attacks) at 0.9098.
CURRENCY FORECAST: in the short to medium term: Asian currencies to appreciate to the US-dollar (mainly those countries operating a trade surplus against the United States). Conversely, the USD is likely to appreciate to the Australian dollar (AUD), Canadian dollar (CAD), British pound (GBP). The USD is likely to decline in value against gold, Chinese renminbi (CNY), Japanese yen (JPY), Swiss franc (CHF), Middle East currencies (Saudi Arabia revaluation in the works?) and other Asian currencies. The USD will not crash, long term interest rates likely to increase to support valuation in the medium term. The USD is getting close to a floor price, say 1.52 -1.55 USD to the EUR. The USD in relation to the Chinese yuan (CNY) will see the CNY cycle back to its year 1993 valuation of 5.6 CNY to the USD within the next 5 years. The yuan crashed in value during the mid 1990’s to ultimately when it was pegged at the 8.28 CNY to the USD level. The USD in relation to the CAD, our educated opinion, we think that the USD will appreciate to 1.10 CAD (91 US cents for each CAD) by year-end 2008.
Let’s flash back to the time of former President Jimmy Carter (1977-81) during a time of a bad economy, high unemployment and high inflation. Surprisingly, this period ended up as a strong dollar window. Of course, the big difference was America at the time was a creditor nation, today a debtor nation. It is important not to get brainwashed in one’s thinking, too much bad news is not all that bad. Moody’s today maintains a triple ‘A’ credit rating for the United States.
Several oil exporting countries are running trade surpluses with America. In our view, we think that the oil price is vulnerable to a price correction. Currency risk remains inherent particularly for oil supply disruptions and/or terror strike in the Middle East sensitive oil production fields. Further, although America is much safer now, the U.S. cannot take for granted the risk of another terror strike. A devastating strike would be bearish for the USD.
The U.S. current account is presently in a slow decline and it will correct to a lower figure, say 3 percent of GDP. At this point, the USD will be getting closer to its bull cycle that may last 6 to 9 years as evidence by historical trading patterns. The current account shortfall is sustainable providing America’s net assets increase greater than the shortfall. The fiscal situation is political. America remains a relatively low tax nation when compared to other industrialized countries. It is likely that taxes will be raised and the fiscal shortfall will be corrected & balanced. This is another bull signal for USD strength.
There has been a tremendous amount of bad media with respect to the USD in recent months, bashing has been sport of the day. Here at BankINTRO.com, we expect an appreciation for the USD against the EUR in 2008-09. During 2009, a further rebound in the U.S. economy and a slowdown in the Eurozone may see further USD gains to the EUR as interest differentials narrow and reverse position. BankINTRO.com’s best guess exchange valuation prediction is by year-end 2008, the USD will trade in a range of 1.35 to 1.45 USD to the EUR and then further appreciate in 2009 to 1.25 to 1.35 USD band to the EUR. The Japanese yen may appreciate to 102 JPY to the USD by year-end 2008. Gold bullion will continue to perform well against the USD but for several other reasons including a supply – demand imbalance, BankINTRO.com envisions gold going over 1000 USD an ounce by 2009.
In addition, an unwinding of those (many hedge funds) betting against the USD will give the USD an exchange bounce in valuation. An unwinding of carry trade positions in the CHF and JPY is also a bullish scenario for the USD, CHF and JPY.
At various times, the USD trades illogical “bad economy – strong dollar”. Further, it is estimated that American’s have upwards of 300 billion USD invested in emerging markets, those monies maybe repatriated home if investment returns are not satisfactory. Of recent macro economic positives to the United States is the huge rise in foreign direct investment into the U. S. economy. With the decline in the USD over the last few years, there has been a rebirth of manufacturing in America with the U.S. still remaining the largest manufacturer in the world at 25 percent of total output. U.S. exports are currently on the rise. All of these events are further bullish for the USD.
During 2008, America’s economy is likely to enter a recession, it may experience economic similarities to what Japan encountered during the 1990’s of sluggish growth and falling prices in certain sectors (ie. Japanese real estate). The JPY during times of weak growth actually appreciated , “bad economy – strong Japanese yen”. The USD is not as weak as many in the media suggest, it is just following traditional historical cyclical trading patterns. Average USD currency bear markets average 4.4 years, now at over 6.3 years, the USD is overdue to appreciate.
The market talk is for the USD to crash. In our view, this is unlikely to happen and we think the opposite may unfold with USD appreciation. Finally, remember that many of these competing currencies to the USD such as the EUR, CNY, JPY themselves are fiat currencies, the majority backed by US-dollars in each of their respective official reserve assets position. It is the concept of fiat currencies that maybe vulnerable, not the USD alone. Keep your eye on gold!