Thread: Dollar Not A Downer

Over a month ago I was reading posts from people that were predicting the dollars doom (I even read one today). One post even quoted a specific date that China was going to dump trillions and cause chaos. A poster even called me because he was concerned. I told him to relax and we watched that date come and go. People started posting how they are concerned about how to cash their dinar in.

Remember there have always been people predicting the the demise of the dollar. The incessant mantra of these people is buy gold. I work with someone like this. These are the people who stocked up on survival supplies for Y2K In fact I just found out my coworker bought a pallet full of MREs for that nonevent that he's still eating down. He also has multiple guns stashed around his condo (this seems to be a common trait also).

Just keep in mind that the U.S. economy is HUGE. Not China or anyone else is going to bring it down just by cashing in their dollars. We didn't get to be the worlds largest economy because we have stupid people running it. We know how to play the game better than anyone, that's how you get to be number one.

So just remember when someone constantly spouts the demise of the dollar they probably have that Y2K mentality and their opinion should be taken lightly. They will inundate you with "facts" and "figures" but remember the dollar continues to rule and China didn't dump theirs.

Here's an excellent article from Business Week regarding the dollars decline. I'll trust the experts at Business Week over faceless/nameless posters.

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Why The Dollar's Decline Isn't A Downer
A steep drop is unlikely, and there are advantages to a further slide

Back in 2002, billionaire investor George Soros boldly warned that the U.S. dollar's value could plunge by a third over the next few years. He was pretty much on target. Since the greenback's peak in early 2002, it has dropped 35% against the euro, 28% vs. a trade-weighted basket of major currencies, and 18% vs. the currencies of all countries the U.S. does business with. What's interesting is, nothing bad happened--except maybe for those investors who didn't sell the dollar short, as Mr. Soros presumably did.

In fact, a lot of good things happened. U.S. companies became more competitive, and exports are now booming. Profits from overseas operations and returns on international investments are soaring as the gains are translated back into dollars. Long-term interest rates are still low, stock prices are setting records, and the economy continues to grow at a moderate clip.

But dollar worries are cropping up again. Through much of the fourth quarter, the greenback was undermined by perceptions in many areas of the foreign exchange markets that the U.S. economy is slowing down sharply enough to warrant the Federal Reserve to begin cutting interest rates sometime in 2007, and most analysts expect the dollar to continue to weaken at least gradually in the coming year.

The worst-case scenario would be a rapid decline that would disrupt global capital flows, damage foreign economies, push up U.S. inflation via higher import prices, and generally complicate the Fed's job of managing the economy and the financial markets. However, that seems unlikely. In fact, the potential pluses from a further downward drift in the greenback will most likely continue to outweigh any minuses--to the benefit of both investors and the economy.

THE DOLLAR WORRYWARTS point to the huge U.S. current account deficit. That gap, comprising mainly the U.S. trade deficit and some other financial transactions, has ballooned to an annual rate of just over $900 billion, or 6.8% of gross domestic product. At that level, the U.S. must attract some $75 billion in foreign financing each and every month to manage its global indebtedness, and the borrowing requirement is almost certain to rise further in the coming year.

The latest concern is that prospects for U.S. economic growth and interest rates relative to those in the rest of the world are fading, making dollar-denominated investments less appealing by comparison. The U.S. will continue to attract the foreign financing it needs. The question is: at what level of the dollar? Since the dollar is the equilibrator between the funds the U.S. needs and the amount foreigners are willing to lend, market pressure on the greenback has been generally downward.

The biggest danger in the coming year is a U.S. recession, but that still looks like a long shot. Currency markets began to fret at the end of last year that the housing recession would spill over to other areas of the economy, perhaps dragging down consumer spending. Worse-than-expected reports on home construction and weakness in manufacturing only fueled those concerns.

However, housing demand is firming up, and inventories of unsold homes are shrinking. Also, a broad effort by businesses to pare down top-heavy inventories of autos and home-related goods, which have sapped the strength of the factory sector, is already running its course. Industrial activity in December picked up, based on the month's rise in the Purchasing Managers Index, to 51.4%, as compiled by the Institute for Supply Management. Also, consumer spending in the fourth quarter is shaping up to grow at a healthy annual rate of about 4%. All this lessens the chances of any sharp or sustained economic weakness.

SO HOW MUCH MORE is the dollar likely to decline in 2007? Economists know short-term currency forecasting can be foolhardy in the rapid-fire world of financial globalization. But, while the dollar appears to be headed lower in coming months, it's important to note that it remains well supported by several forces that will limit the size and speed of the greenback's descent.

One interesting point: Since the currency has declined so much since 2002, it may already be undervalued. Currency analysts at JPMorgan Chase estimate that, based on long-term influences, including country-by-country differences in productivity, prices, interest rates, and risk, the greenback is now about 10% undervalued. If so, that will be an important support in the coming year.

Of course, it's the short-term factors that move the currency markets. While they are pushing the dollar down right now, they are also supportive enough to alleviate worries about a dollar crash. For example, the current account deficit and its financing requirements are not likely to rise as rapidly this year as they did in 2006. Strong export growth is helping to stabilize the trade gap, and slower U.S. demand will cool the pace of imports. As a share of GDP, the deficit will look more stable this year.

ALSO, EVEN THOUGH differences in economic growth and interest rates between the U.S. and some of its trading partners are becoming relatively more favorable for investments in foreign economies, U.S. growth and rates of return are still at attractive levels. And they will stay that way as long as the economy remains strong.

That's especially true for the dollar vs. the Japanese yen. Short-term interest rates in Japan are still at zero, and analysts expect the Bank of Japan to tighten policy only gradually. The greenback will be somewhat more vulnerable against the euro, given that the European Central Bank will most likely continue to lift interest rates this year as the Fed takes a breather.

Other market forces are also pushing investors away from dollar-denominated assets. More U.S. investors are diversifying by looking abroad for higher returns. This comes at a time when global liquidity continues to flow freely and the appetite for risk has not yet been stifled by stringent monetary policies. Also, analysts note that oil-exporting nations and some central banks are also diversifying their holdings away from dollars.

That is especially true for China, which is in the process of reweighting its foreign-exchange reserves toward a greater mix of non-dollar currencies. That shift will allow the dollar to continue edging lower vs. the yuan, which began the year at about 7.8 yuan per dollar. The dollar is down 3.3% from a year ago against the Chinese currency, and futures markets expect an additional 5% decline this year. This year's drop might even be larger than now expected. China's trade surplus ballooned in 2006, and more of its bulging forex reserves will find their way into non-dollar assets. Also, the U.S. continues to pressure China to speed up its revaluation process.

Don't look for much improvement in the U.S. trade gap with China, but a broadly more competitive dollar, combined with strong growth abroad, will continue to lift U.S. exports. In that sense, a lower dollar is an important step toward a rebalancing of global trade.