Here’s What A Declining Dollar Means To You
Today’s article is designed to offer two viewpoints on the current state of
the market/economy. I think it is safe to say bull or bear finds the currently
rally “odd” in terms of its feel. Perhaps my analysis below will shed some
light on why this market is proving to be somewhat challenging.
So, the pundits argue that the dollar decline will help boost our economy.Â
Perhaps they should consider the following, a declining dollar merely transfers
wealth, it does little to create wealth. Under a declining dollar scenario
these are the options:
1. Transfers wealth from the US/Asian consumer to the US/Asian producer
2. Transfers wealth from the European producer to the European consumer
3. Transfers wealth from the European producer to the US/Asian producer
Source:Â GaveKal Research
Naturally, the Fed, with its deflationary comments and resulting weaker
dollar implications are probably hoping to achieve the outcome of option number
three. However, as I mentioned a week or so back, only about 10% of our GDP is
created by export related industries, so this will be of little help at
stimulating the economy.
As far as I can tell the only reason the Fed wants to talk about deflation is
so that it can continue to lower interest rates to hopefully stimulate the
economy. Secondly, the housing market continues to be the one bright spot in
the economy. Any increase in interest rates would deal a severe blow to housing
and perhaps the economy. Other than the cost of technology, little price
deflation seems evident. The result has been another nice move higher in
bonds. However, with yields so low and our dollar depreciating, the risk/reward
for foreigners is looking worse each day. To me, the bond market run is taking
on similar characteristics to the Nasdaq back in late 1999. I would however,
never be foolish enough to try to short bonds, I have merely filed a negative
scenario potential in the back of my head in case there is a catalyst. Again,
referring back to GaveKal Research,
“Once he (Greenspan) announced that ‘something
fundamental has changed and this expansion is different from every previous
cycle’.”……”In the current bond environment, a similar climatic event may be
the FOMC’s official pronouncement that deflation is now a greater threat than
inflation.”
Let’s look however at some evidence that does support
the stories that the economy is indeed improving and that contrary to the
sound-bites, Fed easing this time versus 1990-92 is actually less.
1. GDP is growing above consensus
2. Despite 12 interest cuts, the total value is only
5.25% versus 6.75% in 1989-92.
“In every previous US recession, domestic demand had
grown less than GDP, as American companies worked harder in foreign markets to
maintain output. This time, by contrast, domestic demand has grown considerably
faster than GDP. In 2002 US domestic demand grew by a very healthy 3%, scarcely
a “recession” figure and it is expected to continue growing at a very
comfortable rate – by 2.8% in 2003 and 4% in 2004. Domestic demand also grew in
2001, albeit by a feeble 0.4%, a sharp contrast to the last recession, when
domestic demand fell by -1.1%. Overall, it is clear that the US
domestic economy has been considerably stronger in the current slowdown
than it was in 1991-93, growing by a total of 5.9% in the three years 2001-03,
compared with 5.2% in 1990-92. In fact, had it not been for the collapse of
foreign demand, this slowdown might not have qualified as a genuine “recession.”
Source: GaveKal Research
Do the contradicting pieces of evidence leave most
scratching their heads? You bet it does. The best thing to do is to remain
selective and have a game plan depending on which scenario you see playing out.Â
In the meantime, the intra-day trades have the higher probability of playing out
since visibility continues to be murky.
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As always, feel free to send me your comments and
questions.
Dave