depreciating the dollar

When a country is having economic problems–slow growth, outdated industrial base, weak educational system, balance of payments issues–there are generally speaking two ways to fix things:

–internal adjustment, meaning fixing the domestic problems through domestic government and private sector action, and

–external adjustment, meaning depreciating the currency.

The first approach is the fundamentally correct way.  But it requires skill and demands a shakeup of the status quo.  So it’s politically difficult.

Depreciating the currency, on the other hand, is a quick-fix, sugar-high kind of thing, of basically trying to shift the problem onto a country’s trading partners.  The most common result, however, is a temporary growth spurt, a big loss of national wealth, and resurfacing of the old, unresolved problems a few years down the road–often with a bout of unwanted inflation.  The main “pluses” of depreciation are that it’s politically easy, requires little skill and most people won’t understand who’s at fault for the ultimate unhappy ending.


the Great Depression of the 1930s;

the huge depreciation of the yen under PM Abe, which has impoverished the average Japanese citizen, made Japan a big tourist destination (because it’s so cheap) and pumped a little life into the old zaibatsu industrial conglomerates.


It’s understandable that Donald Trump is a fan.  It’s not clear he has even a passing acquaintance with economic theory or history.  And in a very real sense depreciation would be a reprise of the disaster he created in Atlantic City, where he freed himself of personal liabilities and paid himself millions but the people who trusted and supported him lost their shirts.

Elizabeth Warren, on the other hand, is harder to fathom.  She appears to be intelligent, thoughtful and a careful planner.  It’s difficult to believe that she doesn’t know what she’s supporting.




threatening Federal Reserve independence

trying to intimidate the Fed?

Just before Christmas, news reports surfaced that President Trump was discussing how to go about firing Jerome Powell, Chairman of the Federal Reserve, ten months after having him appointed to the post.  The purported reason:  Mr. Trump was blaming stock market turbulence–not on his tax bill, which failed to reform the system and increased the government deficit, nor on the negative effect of his tariffs–but on Mr. Powell’s continuing to gradually raise short-term interest rates from their financial crisis lows back toward normal.

Ironically, the S&P 500 plunged by about 10%, making what I think will be seen as an important low, as the president’s deliberations became public.

why this is scary

The highest-level economic aim of the US is maximum sustainable GDP growth, with low inflation.  In today’s world, the burden of achieving this falls almost entirely on the Fed (even I realize I write this too much, but: the rest of Washington is dysfunctional).  The unwritten agreement within government is that the Fed will do things that are economically necessary but not politically popular, accepting associated blame, and the rest of Washington will leave it alone.

Mr. Trump seems, despite his Wharton diploma, not to have gotten the memo.  This despite the likelihood that his strange mix of crony-oriented tax cuts and trade protection has made so few negative ripples in financial markets because participants believe the Fed will act as an economic stabilizer.

What happens, though, if the Fed is politicized in the way Mr. Trump appears to want?

The straightforward US example is the 1970s, when the Fed succumbed to Nixonian pressure for a too-easy monetary policy.  That resulted in runaway inflation and a plunging currency.  By 1978, foreigners were requiring that Treasury bonds be denominated in German marks or Swiss francs rather than dollars before they would purchase.   The Fed Funds rate rose 20% in 1981 as the monetary authority struggled to get inflation under control.

The point is the negative effects are very bad and happen surprisingly quickly.  This is more problematic for the US than for, say, Japan because about half the Treasuries in public hands are owned by foreigners, for who currency effects are immediately apparent.







where to from here?

I’m not a big fan of Lawrence Summers, but he had an interesting op-ed article in the Financial Times early this month.  He observes that, unnoticed by most domestic stock market commentators, the foreign- exchange value of the dollar has steadily deteriorated since Mr. Trump’s inauguration.  Currency futures markets are predicting a continuing deterioration in the coming years.  He thinks the two things are connected.  I do, too.

To my mind, what is happening  on Wall Street recently is that currency market worry is now seeping into stock trading as well.  If someone forced me to pick a catalyst for this move (I would prefer not to), I’d say it was the possibility, introduced in the press investigation of Cambridge Analytica, that what we’ve believed to be Mr. Trump’s uncanny insight into human motivation (arguably his principal redeeming feature) may be nothing more than his reading a script CA has prepared for him.  This would echo the contrast between the role of successful businessman he played on reality TV vs. his sub-par real-world record (half the return of his fellow real estate investors while assuming twice the risk).


The real economic issue is not Mr. Trump’s flawed self, though.  Rather, it’s the idea that public policy in Washington generally, White House and Congress, seems to have shifted from laissez faire promotion of businesses of the future to the opposite extreme–protecting sunset industries at the former’s expense.   In this scenario, overall growth slows, and the country doubles down on areas of declining economic relevance.

We’ve seen this movie before–in the conduct of Tokyo, protecting the 1980s-era businesses of the descendants of the samurai while discouraging innovation.  The result has been over a quarter-century of economic stagnation + a collapse in the currency.


More tomorrow.

the amazing shrinking dollar

So far this year, the US$ has fallen by about 14% against the €, and around 8% against the ¥ and £.

A substantial portion of this movement is giveback of the sharp dollar appreciation which happened last year after the surprise election of Donald Trump as president.  That was sparked by belief that a non-establishment chief executive would be able to get things done in Washington.  Reform of the income tax system and repair of aging infrastructure were supposed to be high on the agenda, with the resulting fiscal stimulus allowing the Fed to raise interest rates much more aggressively than the consensus had imagined.  Hence, continuing dollar strength on a booming economy and increasing interest rate differentials.

To date, none of that has happened.   So it makes sense that currency traders would begin to reverse their bets on.  However, last year’s move up in the dollar has been more than completely erased and the clear consensus is now on continuing dollar weakness.


Dollar weakness has caused stock market investors to shift their portfolios away from domestic-oriented firms toward multinationals and exporters.  This is the standard tactic.  It also makes sense:  a firm with costs in dollars and revenues in euros is in an ideal position at present.

It’s interesting to note, though, that over the weekend China lifted some restrictions imposed last year that limited the ability of its citizens to sell renminbi to buy dollars.

To my mind, this is the first sign that dollar weakness may have gone too far.

It’s too soon, in my view, to react to this possibility.  In particular, the appointment of a new head of the Federal Reserve could play a key role in the currency’s future path, given persistent Republican calls to curtail its independence.  Gary Cohn, the establishment choice, is rumored to have fallen out of favor with Mr. Trump after protesting the latter’s support of neo-Nazis in Charlottesville.

Still, it’s not too early to plot out a potential strategy to benefit from a dollar reversal.



The financial crisis and the renminbi

As I apparently never tire of writing, the financial crisis that came to a head five years ago has resulted in an extended period of emergency ultra-low interest rates.  The tried-and-true idea behind this is to give economic activity a boost by making loans carrying negative real interest rates readily available.  “Free” money should make anyone with a pulse willing to borrow and spend.

In the past, these low-interest periods engineered by the Fed lasted at most a year.  We’re now into year six of the current episode.

One result of this extremely long emergency period is that fixed income investors are currently lapping up low-coupon Italian, Greek…even Iraqi..sovereign debt.  And crazy (in my view) fixed income products like contingent convertibles, no-covenant junk bonds and pik (payment in kind) junk bonds, where interest is paid in new bonds, not cash, are all finding eager buyers, as well.

Another is that savers living on interest payments (increasingly Baby Boomers), who are in effect subsidizing the financial rescue, are suffering.  In fact, Millennials have just surpassed Boomers as the most important single demographic force in the US economy.

All of this is well-known.

Another development, though, which may turn out to be the most important in the long run, has escaped notice so far.  It’s the increasing acceptance of the Chinese renminbi in world trade and in investment.

Fifteen, or even ten, years ago, China was content with the fact that all of its trade was effectively done in dollars.  Beijing let Treasury bonds pile up in its coffers, to the point where it rivaled–and the surpassed–Japan as the largest creditor of the US.  It had become uneasy about this situation even before the financial crisis.  Stunned by the meltdown of 2008-09, China decided to offer its currency as a substitute for the dollar.

Until the past year or so, the renminbi has drawn pretty close to zero interest.   This is partly because at first it wasn’t easy for either foreigners or Chinese parties to use the renminbi in trade.  Also, foreigners can’t spend “offshore” renminbi in China itself.

Yes, the renminbi is easier to use today.  But I think a big reason the renminbi is suddenly extremely popular now is the very low-interest rate environment we’re in.  Multinationals with Chinese operations can save 3% – 5% by settling Chinese trade transactions in renminbi.  In other circumstances, this might not be worth the hassle.  But if your cash balances are earning effectively zero and if you have to buy a pik bond or Iraqi debt to get a 5%+ yield, then switching from dollar to renminbi trade settlement is a relative bonanza.

This movement seems to be feeding on itself.  It’s causing very rapid growth in renminbi use, admittedly from a low base.  I don’t think this development has any important immediate investment consequences.  But it could end up making a profound (negative) impact on the dollar and the euro if it continues–as I expect it will.  The ultimate result would be to make renminbi earners much more attractive as investments than they currently are.

The big investment question is when the inflection point will come, when the renminbi will begin to be regarded as a viable alternative to the dollar as the world’s reserve currency.  Perception will likely precede reality by a long stretch   …although I don’t think the tipping point will come this year or next.  I view this as something important to keep in mind, however, so we can recognize what’s happening if this trend develops faster than I now think it will.