I happened to read this article this afternoon after making my post. It was on the front page of IBD on the Monday edition which is delivered on Saturday.
Mike
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Don't Fear The Weaker Dollar — It's Keeping The Economy Afloat
BY IBD STAFF
Posted 11/30/2007
The plunge in the dollar has turned normally calm voices strident and fearful. A weak currency, they say, spells catastrophe for the U.S. economy.
But like much conventional wisdom, this isn't true. Nor is it true that the dollar, to use one favorite recent word, has "collapsed."
You wouldn't know it, however, from recent headlines. This week's Economist magazine, known for its cool-headed discussion of economic events, has this on its cover: "The Panic About the Dollar."
Others see in the dollar's slump a metaphor for America's future — one of decline and waning influence in the world.
To be sure, the dollar is down almost 40% against the euro since 2001. Against the pound, it's off almost 44%. It's even down against the yen, by nearly 13%.
But put in perspective, these declines are neither dangerous nor even undesirable. Over the long-term, the dollar is well within normal bounds. After years of rallying due to massive flows of investment into the U.S., the dollar has simply come down to Earth.
To say it has "collapsed" or "plunged" is simply wrong — as the chart above shows.
Look at the dollar weighted against all its trading partners, not just a cherry-picked few, and you see the dollar hasn't plunged at all. It's about where it was 10 years ago — during the Internet boom.
It rose sharply in the late 1990s, thanks to the outsized returns offered in the U.S. markets compared with elsewhere. Today, after the Nasdaq meltdown in 1999 and 2000, a recession and 9/11, the flood of investment isn't as great.
True, the dollar has weakened against specific currencies — the euro and yen are recent standouts — but that weakness must also be put into context.
The dollar strengthened in the late 1990s due to Mexico's peso crisis, the Asian financial crisis and Russia's market meltdown and ruble collapse. All of these sent capital fleeing to the U.S.
Meanwhile, U.S. stock markets were roaring. Anyone anywhere with surplus cash protected it by investing in America.
Those who think a strong dollar means a strong economy have to explain why, from 1997 to 2002, a time of record dollar strength, the U.S. economy experienced a number of problems — including a stock collapse and recession. Those conditions no longer prevail today.
Reccently, the U.S. also has been cutting interest rates, while the central banks of Europe and Japan barely have budged. So far this year, the Fed has cut its benchmark rate by 75 basis points. By contrast, the European Central Bank has raised rates by 50 basis points. So the spread has widened by 125 basis points in just 11 months.
This means, all things equal, dollar-based returns on interest-bearing investments are lower. Surprised the dollar's dropping?
Add to this concerns over a crumbling U.S. housing market, a shaky bank system and foreign central-bank rebalancing of dollar-heavy investment portfolios and the dollar's relative decline isn't surprising.
Nor is it unwelcome.
The weak dollar already has led to a powerful surge in industrial activity across America's heartland. In fact, if the U.S. avoids falling into a recession in 2008, we may have the much-maligned dollar to thank.
Recent revisions to third-quarter GDP data showed growth of 4.9% vs. an initial estimate of 3.9%. The reason was an 18.9% annualized jump in net exports, which boosted GDP by a full 1.4 percentage points. That more than offset the decline in housing.
Fueled by the weaker dollar, exports were much stronger than expected. Goods exports alone increased a whopping 25% — while imports rose just 4.3%.
Those who fret about the trade deficit — which will exceed $700 billion this year — will get to watch it shrink in coming years as this export boom continues.
What's more, this will continue to feed through to the U.S. economy, boosting domestic activity. The dollar's drop already has had an enormous hidden impact on the factory sector and corporate profits.
Most economists today believe that U.S. economic growth will be far weaker in the fourth quarter of this year and the first quarter of 2008.
But there already are signs of weakness, such as corporate domestic profits, which actually fell 4.2% during the third period, according to data from the Bureau of Economic Analysis.
Ordinarily that would be a disaster. But today, 31.5% of all corporate earnings come from foreign sources. Thanks to the weak dollar, foreign profits of U.S. companies are healthy. In the third quarter they surged 20%. So despite the decline in domestic profits, U.S. companies' net profits actually rose 1.2% in the July-September stretch.
The dollar should continue to bolster the economy at least through next year and maybe longer. Many economists expect the domestic economy to falter this quarter and in the first three months of 2008. But the weaker dollar will continue to underpin industrial activity.
American manufacturing already is booming. Since 2002, despite warnings of "deindustrialization" and a "hollowing out" of U.S. manufacturing, U.S. factory output of durable goods — the sector most sensitive to changes in the dollar's value — has surged more than 25%. Overall, factory output is up 16%.
Even so, some complain that the dollar's decline will lead to our currency being abandoned in favor of the euro. Or the yen. Or some other currency. It is true that central banks are even now selling some of their dollar holdings to balance their portfolios.
That is a wise and prudent thing to do, given that some of them — like China, which has almost $1 trillion in dollar-based investments — have massive exposure to U.S. markets.
But the world's GDP is about $55 trillion in size, and the U.S. makes up 25% of it. Absent a sudden and inexplicable refusal to trade with the U.S. — which buys and sells some $4 trillion in goods and services with the rest of the world each year — other countries will have to keep large amounts of dollar-based reserves.
As the Times of London's Gerard Baker recently noted, "Between 1985 and 1995, the dollar declined by 43% against the word's big currencies. . . . That period was also marked by dire proclamations of the end of U.S. economic power. But it turned out that in those years the foundations were laid for the strongest period of U.S. economic growth in the past 35 years."
What about the euro, used by 25 nations in Europe? No doubt, it will be increasingly used by others as a reserve currency. But remember, it's only 8 years old. Just four years ago, stories similar to those today about the dollar wondered, "What's wrong with the euro?"
The weak dollar, by making U.S. goods more competitive overseas, will sow the seeds of future growth through booming exports, more domestic jobs and a new surge in investment from overseas to snap up bargains in the U.S.
That's not a cause for concern, but of celebration.
