I was sitting at my desk recently, reviewing some articles. One was in the Economist, warning that the dollar was being abandoned, another was a newspaper article suggesting that oil could be priced in other currencies besides the dollar. A third suggested that central banks were diversifying reserves away from the greenback. Sound familiar? You bet. The stories were all from the first quarter of 1995.
The U.S. dollar’s role in the world economy hasn’t changed very much in the last few years. Nevertheless, market participants have a tendency to exaggerate structural influences and minimize cyclical factors. Rather than structural factors, the dollar’s decline is largely a function of cyclical factors.
Part of the dollar’s decline represents an unwinding of the gains scored in the heat of the crisis from mid-2008 through the first quarter of this year. Another factor is its renewed use as a funding currency, encouraged by the ample supply of dollars coupled with the low relative and absolute interest rates. The dollar’s diminished strength is also a result of the microstructure of the foreign exchange market and the trend-following characteristic of many participants.
The U.S. dollar’s impact on the global economy can’t be understated. U.S. GDP accounts for about a quarter of the world economy, which has been relatively stable for the past couple of decades. China’s economic growth has come at the expense of other Asian countries rather than the U.S. The toys and electronics that U.S. consumers used to buy from Japan years ago are now made in China.
Commodities – from hydrocarbons and industrial metals to foodstuffs, fibers and precious metals – are all priced and traded in U.S. dollars. The greenback’s role as an invoicing currency continues as well. Roughly, half of Italy’s exports, for example, are invoiced in U.S. dollars. The dollar is on one side of nearly 90 percent of the transactions in the roughly $3.2 trillion a day foreign exchange market.
Some argue that the U.S. doesn’t make things any more, except more debt. That is not simply a hyperbole, it is factually wrong. The dollar value of U.S. manufacturing output is roughly the same as the BRIC (Brazil, Russia, India and China) countries combined. Moreover, one U.S. company last year applied for more patents than all the BRICs combined: IBM.
There are only five countries other than the U.S. that spend a greater share of GDP on research and development. Two are very small, Iceland and Israel. Two are Finland and Sweden, which have a large niche in telecommunications. The fifth is Japan, which has the highest robotic population in the world, and for good reason. By the end of next year, Japan will have 3 million fewer workers than it did in 2005. The U.S. is the only major industrialized country that has a fertility rate above the replacement rate.
This is not to deny that the U.S. has serious challenges. What country doesn’t? Rather, the point is that there are few countries that are as prepared to overcome those challenges as the U.S. As U.S. interest rates rise relative to Europe’s, the dollar will find greater traction and all the structural flaws that are identified to justify its downward trend will be cast aside, until next time.
Marc Chandler leads the global currency strategy at Brown Brothers Harriman. He is also the author of Making Sense of the Dollar: Exposing Dangerous Myths about Trade and Foreign Exchange. Click on Chandler’s name or the book title for more information.
