Why the U.S. dollar's decline means a rise in global fortunes

Kevin Carmichael, Ottawa — From Wednesday's Globe and Mail

It's both a symptom and a cure.

The acceleration of the U.S. dollar's decline in recent days is creating anxiety for exporters in Canada, Europe and Japan. But in the search to create a post-crisis economy that's less prone to financial catastrophe, the U.S. dollar's decline is widely accepted as a necessary ingredient.

Before the crisis, countries grew overly reliant on U.S. consumers, who created an unsteady platform for the global economy based on debt-fuelled spending supplemented by a favourable exchange rate. Now, policy-makers in the Group of 20 nations are trying to spread out consumer demand to Asia and elsewhere, a process that will both result in, and be facilitated by, a weaker dollar.

“What's wrong with the dollar weakening?” said Sophia Drossos, a currency strategist at Morgan Stanley in New York and a former economist at the U.S. Federal Reserve. “There needs to be a rebalancing. I think it's moving in the right direction.”

An index that measures the value of the U.S. dollar again six major currencies, including the loonie, the euro and the yen, fell to the lowest in 14 months Tuesday because investors seeking short-term gains are gaining confidence in the global recovery.

When the world economy appeared on the verge of collapse last autumn, investors rushed to the dollar, seeking safety in a legal tender that's accepted most everywhere and backed by a government that has never defaulted on its debt.

A year later, investors are back on the hunt for yield, selling their dollars to buy everything from futures contracts on commodities, to European debt, to Brazilian reals – anything that looks better over the next few months than the assets of a country with a record budget deficit, a benchmark interest rate near zero and one of the slowest growth rates among major economies.

Canada's dollar topped 97 U.S. cents for the first time in 13 months Tuesday, continuing a rise toward parity that Prime Minister Stephen Harper Tuesday called a “concern.” As the loonie rises, Canadian goods become more expensive in international markets already suffering from a lack of demand.

But that kind of pain is what policy-makers accepted when they pledged last month at the Group of 20 Summit in Pittsburgh to adopt – and in some cases, resist – policies that will reshape the global economy into something that is less prone to financial meltdown, if a little less dynamic.

For Americans, the falling dollar will make imports more expensive, curbing the American consumer's impulse for debt-fuelled spending. At the same time, the country's battered manufacturing industry should get a lift as its exports become more competitive, offering the hope of employment in an economy badly in need of jobs.

In the same way that a crisis in the world's largest economy sunk the world into its deepest recession since the Second World War, a rebound in the United States should translate into stability elsewhere, investors and economists said.

“This is kind of good for the global recovery,” said David Baskin, president of Toronto-based Baskin Financial Services, which manages assets worth about $300-million. “It's unclear to me that you can have a U.S. recovery and have no one else recover.”

Paradoxically, the U.S. dollar's weakness is the result of rising confidence in the global economy's prospects. The drop picked up speed last week when the Australian central bank raised its key interest rate, citing a strengthening global economy, especially in Asia.

The Australian move triggered expectations other countries will eventually follow suit, including Canada. Though the Bank of Canada has said it expects rates to remain at rock-bottom levels until next summer, there is upward pressure on some rates. Just Tuesday several major Canadian banks hiked five-year mortgage rates by 0.35 percentage points to 5.84 per cent.

The longer-term benefits of a weaker U.S. dollar will test the resolve of politicians who face explaining them to constituents who will bear the brunt of the short-term pain.

Mr. Baskin said he fears the gyrations in foreign-exchange markets will stoke reactionary policies aimed at protecting exporters, but which will ultimately end up slowing trade and the recovery.

The political impetus to mitigate the harmful effects of the U.S. dollar's descent is understandable. In Canada, for example, Canadian Manufacturers & Exporters, a trade association, estimates that the country loses 25,000 factory jobs for every one-cent increase in the loonie against the U.S. dollar.

So far, Mr. Harper appears to be taking the longer view.

Speaking to reporters in Vancouver Tuesday, the Prime Minister echoed Bank of Canada Governor Mark Carney's warnings that a persistently strong currency will slow Canada's rebound. Still, Mr. Harper said the Canadian dollar's rise is at least in part due to forecasts by the International Monetary Fund and others that predict Canada's gross domestic product will expand faster than that of most other major industrial countries.

“There are many risks, some of them within our control, some of them beyond our control, and obviously the value of the Canadian dollar is a risk to our recovery,” Mr. Harper said. “I don't think it's a risk to choking off the recovery, but if it goes up too rapidly, it does have difficult effects on our economy.”

Last week, Finance Minister Jim Flaherty said the biggest factor behind the U.S. dollar's weakness is the budget deficit, which, according to the Congressional Budget Office, was $1.4-trillion in the fiscal year that ended Sept. 30, greater than India's GDP.

The U.S. dollar's decline also reflects a broader recognition by international investors that Asia is taking on a greater role in driving the global economy, investors and economists said. The U.S. economy will expand 1.5 per cent in 2010, compared with 9 per cent in China and 6.4 per cent in India, according to the IMF.

“This is what you would expect with a transition like this from one region to another,” said Daniel Bain, president and chief investment officer at Thornmark Asset Management Inc. in Toronto. “When currencies move, they move in broad trends. I don't see anything that is going to shift away from current trends.”

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My observation - this article talks about changes in the US dollar in the context of world economies without even mentioning gold. In the short-term, the quick alternative to the dollar has been gold, but that may not persist as other currencies (e.g South Africna Rand, Brazilian Real) and commodities/stocks of other countries may become atrractive investments as well; gold is not the only alternative.

SGR seems range-bound right now. If there is still a general stock market correction coming, SGR may also drop (unless it comes out with the once-again-delayed 43-101 and other stellar results). I expect SGR will be over $5 and likely higher in the longer-term; not sure what to expect in the next month or two.

JMHO

NL