Over enthusiam

One of the most surprising and puzzling economic trends is the unparalleled strength of the U.S. dollar.

That trend has momentum, but it seems to depend on momentum for the most part, not on facts.

While the prime rate of interest is 3.4 per cent, compared to 2.7% here, there are other things that should be considered. For example, the United States has not run a favourable balance of trade in 40 years – in other words it has imported more than it has exported.

By that very fact, it is obvious that the U.S. dollar is overvalued in world markets, and according to the latest data, ran a deficit of $4.9 billion for that month. Clearly then the U.S. dollar is at an unjustified premium.

It must be noted however, that a factor in U.S. dollar strength is the fact that the U.S. economy is the strongest in the world, and the market for the U.S. dollar is highly liquid, as the dollar can be traced easily in large quantities.

The ramifications of that overvaluation in world markets makes commodity prices lower; it takes fewer U.S. dollars to purchase a commodity. That is very harmful to our economy, making agricultural and all raw materials lower in price – notably right now oil prices, and of course, reflected in the price of gold.

Our economy is more commodity based than most others. In U.S. dollar terms it should be noted too that the price of gold is 20% above the Canadian price.

What are the principal reasons for this distorted price picture? As stated above, the disparity in short-term interest rates attracts placing funds in that currency. Also, the recovery in the U.S. economy from the 2008 recession has been about the best in the world. Too, the worldwide acceptance of the U.S. dollar makes it the currency of choice. However, now China is opting to partly supplant that with the Chinese yuan, and has been buying gold in large quantities to back up the strength of that currency in public confidence.

Aside from the strength of the U.S. economy and its balance of trade in international markets, there are other reasons for longer-term scepticism about the U.S. dollar.

The U.S. political system to a large extent is dysfunctional. Even newly-elected presidents are unable to get much legislation passed. The last effective U.S. president was Lyndon Johnson, who capitalized on the sympathy engendered by the Kennedy assassination. Also, the lower house of Congress has to hold elections every two years, and with the gerrymandering of political boundaries most incumbents are assured of re-election and can ignore public sentiment.  Hence, those who operate based on the momentum will be the losers and logic will be asserted.

In the long run the sustaining factors of the U.S. dollar will end as logic eventually prevails and all commodity prices will be the beneficiary, very bullish for our economy.

 

 

Bruce Whitestone

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