Sometimes you picture me, I’m walking too far ahead you’re calling to me. I can’t hear what you’ve said– then you say–go slow. I fall behind. The second hand unwinds. If you’re lost you can look–and you will find me, time after time If you fall I will catch you–I’ll be waiting, time after time. These lyrics are from Cyndi Lauper and Bob Hyman’s melancholy song which was released on her debut album She’s So Unusual in 1983. While the song is a love song describing a long and relationship between, it may as well be describing the relationship between the American political system and the US dollar.
The trade weighted value of the US dollar is an index of the weighted average value of the dollar relative to the currencies of a broad group of major U.S. trading partners. The value of the dollar is mainly related to simple supply and demand. The value of the dollar goes up when foreign buyers purchase from US producers and settle accounts using dollars. The same is true for investors purchasing US based bonds, stocks, property or other assets, all of which need to be settled in dollar terms. In addition, the dollar is considered to be a safe haven for individuals during times of economic uncertainty. So when trouble strikes in Syria, Turkey, Russia or Venezuela, people with assets in those countries often convert them to dollar based assets (think pricey New York City apartments), which also increases the value of the dollar. The opposite is true when foreign investors think the US economy might be in trouble, and sell dollar denominated assets thereby increasing the supply of dollars in the currency markets.
Speculation can also move currency values in the short term. This is because trillions of dollars are traded daily on currency exchanges, far above the amount of currency needed to settle trade deals. If investors in the market think that events will harm the US economy, or reduce interest rates and returns on investments in the country (for example recessions reduce the value of real estate) they may sell dollars. Conversely if they think interest rates will be increasing in America due to strong demand, they may buy dollars.
The trade weighted value of the dollar peaked in the Winter of 2002, having run up dramatically during the latter part of the 1990s. This was a period of outstanding growth in the US economy and generally higher interest rates. Following the brief recession that occurred in the winter of 2001 the value of the dollar began to fall, to the point that by the middle of the last recession it was reaching its all-time lows. The dollar has remained weak throughout the Fall of 2014, when in spite of a terribly weak US economy, it began to spike. This was mainly because the US Federal Reserve started to tighten monetary policy by in effect, reducing the creation of new dollars. At the same time both the Europeans and the Japanese went on currency printing binges. In addition, oil prices began to fall, which reduced demand for dollars to purchase oil – particularly from the Gulf States. So investors saw a better chance of higher returns and renewed growth in the US relative to its major trading partners.
The dollar’s rise saw another surge after Donald Trump was elected President. This was because investors believed than many of the policies touted by the new President, from tax reform, to infrastructure investment, to deregulation might have beneficial impacts on the economy. The rise in US equity markets coincides with the increase in the value of the currency.
This increase began to fade when the new Administration moved into the white house, and has begun to snowball in recent weeks, with the dollar down by 6 percent from its peak. It is obvious that the problems that the President has been having managing his message and Administration has had some effect, but more importantly, it seems as if investors no longer believe that the Republic Party can do much to stimulate the economy, particularly through tax reform.
The lower dollar does benefit exporters, and many economists believe that a weak currency is good for the economy because it strengthens exports and increases tourism. This Mercantilist point of view; however, does not consider that it also harms importers, consumers, and Americans who might want to travel abroad. As a more classically trained economist, I am less concerned with the effects of currency valuations, at least if the Central Bank is not manipulating it. I see the value of the currency more as an indicator rather than a factor in economic growth. A strong dollar is a vote of confidence in the American economy, while a weakening one is a leading indicator that we should be worried about future growth prospects.
So what to take from spike in the currency after Mr. Trump was elected President, and the subsequent fall back to pre-election levels? It seems that investors (and a plurality of American voters) believed that the policies that the President was campaigning on would indeed make America great again. Unfortunately, the President has not been able to execute on his promises, and has not been able to keep his party focused. Maybe as the song says, the dollar was just walking too far ahead, but unless the politicians in Washington finally hear what [the public] said, I for one, think that like Ms. Lauper, the economy will go slow, and fall behind. Just like the dollar.