The
United States' massive trade deficit exerts
pressure on the US dollar as currency is shoveled
abroad in return for goods and services. As the US
economy is slowing down and possibly sliding into
recession, the rate at which the trade deficit
grows may also be slowing; in September, this
deficit was "only" US$64.3 billion - still near
record territory but not as bad as economists had
predicted.
Does this mean the worst for
the dollar is over? After all, it now costs over
50% more to pay for a 100 euro hotel room than six
years ago, assuming the hotel
has not raised its price. Can it get worse? Since
you probably cannot afford to go to Europe on
vacation anymore, it may not matter to you. But
even if you do not travel abroad, it does matter
to you as your purchasing power erodes; among
others, the cost of imports and commodities,
including the price you pay at the gasoline pump,
is likely to go up.
The trade deficit is a
component of the broader current-account deficit,
which also includes investment income. The
current-account deficit is the shortfall that
needs to be covered by foreign investors for the
dollar not to fall. Last year, foreigners needed
to purchase $805 billion in dollar-denominated
assets just to keep the dollar from falling.
That's more than $2 billion every single
day.
As the US economy is slowing down,
what matters is whether other factors propping up
the dollar slow down even faster. The most
apparent one is whether foreigners will be as
inclined to invest in a slowing US economy.
Another is trade policy. A new Congress may take a
tougher look at "protecting" local jobs. If such
policy is not engineered very carefully, the risk
is high that it will hurt all those who have been
able to adjust by taking on jobs working in an
industry dependent on imports; the trade deficit
makes the dollar vulnerable should America's
trading partners not agree with new rules or
restrictions on trade.
Note, too, that we
are talking about slowing growth in the deficit,
not about reversing the trend, nor about
eliminating an enormous cumulative deficit that
has been built over time. We only need to have a
negative change at the margin of any parameter
that supports the dollar for the dollar to weaken
further.
The main reason the dollar has
not fallen faster and more sharply is that it is
in no one's interest for the dollar to fall. The
most prominent recent example of the pain a weak
dollar can cause is with Airbus, the European
aircraft maker. It is an "old-economy" company
with bureaucratic structures seemingly incapable
of adjusting to a more rapidly changing world.
Mistakes in today's world are expensive, and
Airbus has had a number of major missteps.
In addition to its internal problems, the
weak dollar makes it operate at a significant
loss. While many rightfully say Airbus is too
"important" to fail, it has the hallmarks of being
yet another disastrous European project along the
lines of the overly expensive Eurotunnel project
that has created losses for multiple generations
of investors (Eurotunnel is the rail route under
the English Channel connecting the United Kingdom
with mainland Europe).
At least in Europe,
the central bank (ECB) employs a strong dollar as
one of its tools to exert pressure on European
governments to induce reform. The pain of too
strong a euro is shrugged off by ECB president
Jean-Claude Trichet. In Asia, however, economies
are hopelessly dependent on exports to the US and,
in our assessment, will do anything in their power
to keep their own inflated economies afloat.
In plain language, this means that Asian
countries are likely to engage in competitive
devaluation, leaving the euro as the de facto
winner as pressures on the dollar mount. Gold- and
resource-rich countries are also likely to
continue to benefit from this environment. In our
assessment, dollar cash is a risky rather than a
safe asset; investors may want to consider
diversifying their portfolios to be prepared for a
potential further deterioration of the US dollar.
The next time you hear about the trade or
current-account deficit growing at a less brisk
pace, evaluate why this deficit has gone down. Is
it because of a shift in policies to induce
consumers to save and invest? Or is it because the
economy is slowing down?
As consumers
cannot afford to spend as much as in the past,
their savings rate is bound to go up as well; but
there is a difference between savings going up
because consumers cannot afford to spend anymore
and an environment that fosters savings and
investments. Given that most politicians are
interested in short-term growth no matter which
party they belong to, it remains to be seen
whether the new US Congress will pave the way for
a change. Remember that we do not have an
"ownership" society when all we own is debt.
Axel Merk is the portfolio
manager of the Merk Hard Currency
Fund, a no-load mutual fund that
invests in a basket of hard currencies from
countries with strong monetary policies assembled
to protect against the depreciation of the US
dollar relative to other currencies.
