What our enemies the dollar bulls are saying:
nvy
By Scott Anderson
04/2/01 12:00 PM ET
The U.S. stock markets have tumbled
and economic growth is dangerously
close to recession, but the dollar
continues to power ahead. It turns out
that the dollar is receiving a temporal
boost due to weakness abroad, and a
longer-term boost from U.S.
productivity gains and a
market-friendly structure that will
continue to serve it well in the months
ahead.
The temporal boost comes from the
popular notion that U.S. dollar
investments provide a safe haven in
times of global economic and financial
crises. The U.S. does not exist in a vacuum, and relative performance indicators
continue to favor the U.S. and the dollar. The U.S. trade deficit ballooned over the last
year to $369 billion, which under normal circumstances should weaken the currency,
as Americans need to sell dollars in order to purchase imports. More than offsetting
this phenomenon, however, are the foreign capital flows investing in U.S. assets of all
types. The demand for U.S. dollars to buy financial assets is keeping the U.S. currency
strong.
Through December of last year, the most recent data point available, foreign investors
had not given up on U.S. financial assets by any stretch of the imagination. Foreign
net purchases of U.S. stocks were up more than 63% in 2000, totaling $175 billion.
This was after annual stock market declines of over 30% for the Nasdaq and a near
10% loss for the S&P 500 in 2000. Foreign net purchases of corporate bonds totaling
$182 billion in 2000 were also up a healthy 14%. The greatest increase in demand
came from foreign net purchases of U.S. government corporate and federally
sponsored agency bonds, which grew 66% in 2000 to $153 billion. Foreign capital
flows for these three asset classes totaled $510 billion in 2000, far outdistancing the
U.S. trade deficit at $369 billion. Capital appears to be flowing in from all over the
world, but the largest increases are coming from Japan, the United Kingdom, and
continental Europe.
Indeed, the United States appears to be the largest beneficiary, as capital continues
to flow out of Japan to escape the escalating financial and economic crisis in that
county. Japan's problems appear to be much more profound and much less transitory
than the economic problems in the U.S. After a decade of bad loans, Japanese banks
are starting to fail again, retail sales are stumbling, exports are declining, and industrial
production is running in reverse. On top of the economic and banking sector problems,
the Nikkei is at a near 16-year low and the Bank of Japan has dropped interest rates
back to zero, giving Japanese institutions and investors few domestic options on
where to store their wealth.
Expectations are also falling for the European economy. Germany's IFO business
confidence indicator is showing marked weakness and industrial output in the euro
area declined by an alarming 1.9% in January. Also, industrial production in the United
Kingdom fell by 0.6% over the last three months.
Global equity markets are being pounded just as hard as the U.S. The global MSCI
index is down more than 15% year to date. The FTSE Eurotop 300, which tracks
European stocks is down approximately 17% year to date, while Japan's Nikkei 225 is
off by 12% so far this year. Emerging market bond yields are now averaging about
770 basis points above U.S. Treasuries as budget deficits and liquidity problems have
spooked investors from Turkey to Argentina.
Still, beyond this notion of the dollar simply being a safe haven lies a more telling
reason for the dollar's strength. The outstanding regulatory and legal structure in the
U.S., its flexible labor and product markets, and its deep and liquid financial markets,
all provide the United States a decisive comparative advantage in attracting foreign
capital. A recently released study by PricewaterhouseCoopers produced an opacity
index that measures the effects of unclear legal systems and regulations,
macroeconomic and tax policies, accounting standards and practices, and corruption
in the capital markets of 35 countries. The U.S. ranked second for the most
transparent system just behind Singapore. This transparency in the U.S keeps interest
rates low and foreign capital flowing in.
In short, one shouldn't expect a weakening dollar to bail the economy out of its growth
deficit, as the long-term fundamental factors behind the strong dollar remain intact.
This is bad news for export dependent industries that could use the competitive boost
that a weak dollar would provide. However, a strong dollar does free the hand of the
Fed to continue to lower interest rates without fear of creating a dollar collapse and
inflationary spiral. The dollar's strength is also reassuring, as it reflects the fundamental
strength of the U.S. economy. |
