PROPERTY-cooling measures announced in July have dampened sentiment towards the Singapore property market, says the latest quarterly Real Estate
Will the US dollar collapse?
Here is an answer I wrote back in May 2011. I believe the arguments still apply in the medium-term, although I certainly wouldn’t say it’s a great location to get long dollars here, and any next leg up in the dollar may not be led by a rally against the currencies currently the focus of the commentariat.
Obviously the crude price has made a certain move since I wrote this piece, and may not continue to be a factor from here (also situation in emerging markets, not covered in this piece). Volumes are a different story, and the influence of the energy production boom on the US economy (at a macro level, and on the fortunes of energy consumers) remains far from exhausted.
A couple of more recent pieces:
A jump in energy-related exports and a steep decline in oil imports lowered the U.S. trade deficit in December to nearly a three-year low.
The improvement suggests the economy grew in the October-December quarter instead of shrinking as the government estimated last week.
A brighter outlook for trade also illustrates how a boom in oil and gas production is reducing crude oil imports and making the U.S. a leader in the export of fuels. And it shows that higher domestic sales of fuel-efficient cars are lowering dependence on oil.
The trade gap fell nearly 21 percent in December from November to $38.6 billion, the Commerce Department said Friday.
Total exports rose 2.1 percent to $186 billion, driven in part by record exports of gasoline, diesel and other fuels.
At the same time, imports declined 2.7 percent to $225 billion. That was largely because oil imports plunged to 223 million barrels — the fewest in 15 years.
“While we may see some give back in the coming months … the trend of a narrowing petroleum trade gap will continue to drive improvement in the overall trade balance,” said Michael Dolega, an economist at TD Bank, said in a note to clients.
HOUSTON — Growing production of U.S. oil and gas is helping, according to a federal report Monday.
Dramatic growth in the export of refined petroleum products, such as jet fuel and gasoline, has led the way. The value of net refined exports increased 55 percent in 2013 over the prior year, reaching $33 billion, according to the U.S. Energy Information Administration.
U.S. refiners are finding cheaper domestic alternatives to overseas oil, causing a rally in the ratio of refined fuel exports to imports. Overall energy export values increased 8 percent in 2013 over the prior year.
Total energy imports to the U.S. fell by 11 percent for the same time period.
The shifts have helped push down the U.S. trade deficit to its lowest level in four years, because of the importance of energy imports and exports. Energy accounts for 15 percent of gross goods imports and 7 percent of gross goods exports, the EIA said.
The increase in production also has dampened imports. Natural gas imports fell 14 percent in 2013 over the prior year and net crude imports fell by 16 percent.
Going forward, one big driver that has not been of importance previously in this recovery and dollar rally will be the labour market – in particular wage growth – and the impact on interest rate differentials. Stronger US growth means rising yields, which on balance will tend to be dollar supportive.
It goes without saying that this is not intended to be investment advice.
I recognize that the length of this answer goes beyond being of merely unfashionable length – it was written for a different audience originally – but perhaps it may be of interest to those who have the interest and time to think about macro trends (like the outlook for the dollar). One ought to make things as simple as possible, and not simpler, and unfortunately currency valuations are not quite the simplest phenomenon in the financial world. It may also serve as some use to illustrate one less common way of thinking about markets that did pay off in this particular instance.
Since the Federal Reserve trade-weighted nominal broad dollar index peaked at
129.68 in February 2002, it has depreciated by 27% to its recent monthly closing low
in July of 94.84. Although inflation since that time has been significant, it has not
tended to be lower in America’s trading partners, and the depreciation in the real
broad exchange rate over that time has not been significantly different at 28.6%.
There is overwhelming agreement amongst financial commentators that this decline
is not only fundamentally justified, but that it is only the beginning of a much larger
decline that presages the end of America as the dominant empire, the destruction of
all nominal values amidst money-printing induced hyperinflation and a breakdown
in and disintegration of the social and political fabric that constitutes the nation.
There is simply no prospect of a stabilization in the triple deficits faced by the US –
negative private savings, a worsening fiscal deficit and therefore a continually
deteriorating current account. The only option is to save oneself by investing in
foreign currencies, foreign and equity markets, commodities, precious metals and in
more exotic hard assets such as art and infrastructure.
Not only have many foreign nations (emerging markets in particular) improved
their infrastructure and quality of their governance, but they are now clearly
challenging the US for its former position of supremacy, and to listen to some
authors there is not even any longer a challenge – the US has lost its place, and not
only cannot regain it but does not deserve to. As investors have lost confidence in
every institution and strategy that they once held sacred, they have abandoned what
is abstract and looked to what is concrete – when one visits the emerging world one
can see for oneself the very radical and genuine changes that have taken place and
persuade oneself that an even brighter future lies ahead.
I would like to consider the merits of this view more carefully, both from a shorter-
term investment horizon of one to two years, and from a longer term one of a decade
plus. I will start by considering the question of valuation of the US dollar vs other
currencies from a couple of different perspectives; it is true that in extremis one can
wait for a lifetime before a currency returns to fair value, but I have always found it
a useful starting point to ground the analysis. There are certainly more sophisticated
models than purchasing power parity (PPP) that incorporate other important
influences, but I shall focus on this simple approach to valuation for the time being.
[PPP table of dollar valuation based on 3 different metrics – 1 shown here]
This suggests an undervaluation of the US dollar by approximately 35%. It is
possible that the Big Mac index is biased by relative factor availability (cheap but
relatively unproductive labour is abundant in poorer, less developed countries, and
this tends to bias the results to make their currencies seem cheaper on PPP-based
measures of valuation), but I note that this gives a result close to that obtained if we
use the OECD valuation measure on its own (which suggests an undervaluation of
30%). Interestingly this suggests that the dollar was actually a touch cheap in 2002 at
the beginning of the latest bear swing.
There is a striking difference between the results of this analysis and the popular
conception that the dollar needs to depreciate until US wages reach Chinese levels.
This conception simply is not founded in reality since it does not take into account
relative productivity differences. Proprietary analysis by the ISI Group shows the
US to have very competitive unit labour costs internationally – lower than Germany,
and comparable with South Korea. Anecdotally we see many signs of the re-
localisation of production that tend to confirm this thesis – Indian call centres have
moved activity back to the US, and the difficulties of doing business in China
combined with the high rates of wage inflation mean that at the margin a few years
forward the US becomes a more attractive location. In essence the first wave of the
post-internet global labour arbitrage is complete, at least as far as the US is
Beyond exploring valuation, I have over the years found it useful to consider the role
of sentiment in evaluating the attractiveness of an asset. In investing we are trying
to buy cheap assets. Since any deviation of an asset can be considered a ‘risk
premium’ of some sort, we are trying to identify assets where the risk premium
reflects an irrational perception of the risk or of impairment to the underlying value
of the asset. This means that we prefer to buy an asset that we can identify as being
hated, and we prefer to sell assets that are universally loved. Usually a hated asset is
hated for good reasons, but these may be in the price or it may be the case that things
are about to look up and that the underlying factors weighing on the price were
How would one assess sentiment towards the dollar and towards the USA (peoples’
feelings towards currencies often reflect how they feel about the issuing nation, so
there are always aspects of national prestige mixed in with the hard, cold
calculations of modern finance)? I would say that it is unbelievably grim. It would
be hard to imagine sentiment being much worse than it already is. Here are some
recent cover stories from the Economist magazine. Note the themes of fighting and
disintegration (manifestations of a low social mood that tend to be found closer to
major lows than to major highs)
But perhaps, despite its undervaluation, there are good reasons to be diversified out
of the dollar into other currencies. Here are some of those that come to mind, and
have often been raised by the proponents of permanent dollar weakness.
•Chronic current account deficit
•Unmanageable debt load (public and private) vs GDP
•Japanese experience suggests deleveraging will require monetary policy support
for years to come to support GDP growth. QE 3, 4, 5 ?
•Very polarized political scene, disturbing lack of social cohesion suggests taking
tough decisions will be hard. Majority of households do not pay income tax! Political
swing away from policy elite towards a more populist direction (‘Tea Party’
ascendancy). Republicans playing chicken with Democrats over the budget – risk of
threatening US credibility and prestige in bond market. Ongoing black swan
possibility of a technical default?
•Secular decline in US civilization accompanied by a genuine ascendancy of the
emerging world. Declining moral qualities (restraint, willingness to sacrifice for the
future), loss of optimism. Is the American Dream dead? Wages in emerging world
still cheap in USD terms vs those of US workers.
•Stagnant real wages since 1970s; declining overall participation rate since 2000 –
very much worse for men, particularly those from minority groups (that are in the
sample statistically less skilled).
•Iraq, Afghanistan, Libya. Wherever next ?
Mass perceptions of national prestige are not wholly irrational, but they are often
shaped by images. The past decade has seen a striking contrast in the development
of major US cities when compared to what has taken place elsewhere. Some have
taken these as signs of a secular decline in US civilization.
Compare the Lee Plaza Hotel in Detroit –
to the still very-rapidly developing Shanghai skyline:
The tallest US building was completed as far back as 1973 (unlike in the Arab world
and in Asia where new highs are set quite frequently). Possibly this reflects a loss of
ambition and optimism in the US mind.
The Austrian economist Bohm-Bawerk, in his Positive Theory of Capital, observed
that as a civilization develops its members become more and more able to consider
the longer-term consequences of their actions today for the future, and to restrain the
gratification of their present impulses in order to have greater fulfilment at some
future time. He linked therefore the development of a society with rising future time
orientation and a rising personal savings rate.
Moral Decline – End of Self Restraint?
The decline of the personal savings rate as we see in the chart below has
certainly accompanied changes in culture and personal conduct that could be
considered jointly a consequence of greater contemporary American emphasis on
instant gratification. If I am right, then a consequence of this has been also the
neglect in the political domain of problems which will eventually become very large
but have not yet bitten.
Declining future time orientation reflected in personal savings rate
The current account by the National Income equations is identically equal to the sum
of household savings, corporate savings and government savings. It seems strange
to speak of government savings in our era, when the deficit/gdp path seems to have
been on a one way trip south
Horrible Deficit/GDP Path
As we would expect, this has been reflected in a deteriorating trade balance and
Declining Trade Balance/Current Account
Amidst much talk of the hollowing-out of US manufacturing and ‘jobs moving
abroad’, we have heard talk of the declining labour force participation rate:
Declining Participation Rate
and the picture is even worse for men (it is particularly bad for some minority
groups and for lower-skilled workers)
Picture worse for Men (particularly bad for some minority groups and for lower-
Now at least we have a good grasp of some of the very negative longer-term
fundamentals for the dollar (although I have not addressed questions of debt
sustainability at this juncture). Having given this concession to the dollar bears, let
us consider whether these bearish arguments are in fact complete.
•Is the current account situation really so bad? We ought to examine the detail.
•Bears on the US want to have it both ways – to believe that prospective US growth
will be weak due to dampened animal spirits, and that the current account will
continue to worsen leading to further dollar weakness.
•But dampened animal spirits ought to lead to rising/high savings rate and a
stabilizing/improving current account. Not likely to be associated with large
portfolio outflows on the capital account either.
•Danger of extrapolating recent experience indefinitely out into the future. Every
natural phenomenon has an ebb and flow. Possible we might see a stabilization or
turnaround in participation rate, government spending/fiscal deficit and national
Please look carefully at the charts that follow. Further discussion below.
Recent evolution of savings rate
Trade balance ex Petroleum (bn)
US Trade Balance ex Petroleum (%GDP $)
US Trade Balance Petroleum Products Component (Current $)
Petroleum Balance (estimated volume)
US Crude Imports (Value)
US Crude Imports (Volume Proxy)
So despite the gloomy trend for the evolution of the savings rate, looking at the more
recent data indicates a potential change in trend. Given the horrible scare that
people have experienced, it is likely to be quite some time indeed before they feel
ready to live once again on the never never and they are likely to want to rebuild
their balance sheets by accumulating savings – so this is one positive aspect of the
brutal period we have lately experienced.
I broke down the trade balance into two components – petroleum and ex petroleum.
If we look at the ex-petroleum part, we can see that this has actually been improving
even in nominal USD terms for quite some years – what has led to the deterioration
of the overall number has been a steady deterioration in the component coming from
Drilling down once again, we see that this is a consequence not of rising
consumption, but of a rising oil price. (As every schoolboy knows, crude has been in
a bull market for the past ten years). So, if we want to understand better the
prospects for the deficit, we need to consider what is likely to happen to US imports
of crude and to the price of oil.
Until recently, any discussion of the outlook for the future availability of crude oil
has been dominated by the perception that we have reached peak oil, and that from
here the output would inevitably decline, implying a bleak future of tremendously
expensive oil (given the very rapidly-rising demand from the emerging world) with
subsequent rationing and resource wars. Under so-called Olduvai theory, the whole
of industrial civilization was a mere blip between two periods of primitive barbarian
W.D. Gann spoke of an economic and financial cycle that involved old men passing away and new men coming to power. I have observed previously how the timing of the passing away of important figures tends, for whatever strange reason, to
synchronicitously reflect major shifts in society and the economy. From this
perspective, it was intriguing to see that Matt Simmons, the most respectable
proponent of Peak Oil Theory passed away last year.
What shifts might there be with regards to social perception of the outlook for
energy supply? One striking development over the past five years has been the new
application of a process for extracting natural gas from shale. The surge in
supply (amidst weak demand conditions) has been associated with a collapse in the
spot price of natural gas that one could barely have imagined just a few years back.
We are now seeing increased output of shale oil. Last year saw an upturn in US
crude output for the first time since 1986.
Shale Oil (Tight Oil)
Natural Gas and Crude Oil Production
Natural gas production at all-time highs. Upturn in US crude output for first time
Collapse in Natural Gas Prices following Shale Gas coming on line
Combination of rising supply (shale gas), limited storage availability and still-
depressed US electricity demand vs peak
US Shale Output (Liquids k b/d)
Per a US consultant, US liquids output could add 700k b/d in Gulf of Mexico, 200kb/d in biofuels, 100k b/d oil from natural gas formations, 400k b/d natural gas liquids. So they estimate a total increase in US liquids output of 3.3mm b/d by 2015.
How significant is 3.3mm b/d increase in US production?
–1973 6.1 mm b/d
–1980 6.4 mm b/d
–1990 7.1 mm b/d
–2000 10.5 mm b/d
–2010 9.5 mm b/d
So very simplisitically, this order of magnitude increase would reduce the net import requirement for crude by 1/3. The gross trade balance was -$48.2bn; ex petroleum it was -$16.9 bn. Presuming no change in price and everything else held the same, this would reduce total trade balance to -$27.3 bn.
But supposing we were to see a correction in the price of crude (something to be expected given increased supply, but I have explored elsewhere some reasons relating to monetary policy as to why this kind of fall might be possible) by as much as 40%, it would put total trade balance at -$23bn – levels of 1999 in current USD, and even better as a share of GDP.
In 1999 DXY was 100, 32% richer than current levels.
So here there is a scenario that could lead to a substantial improvement in the
perception of dollar fundamentals. One needs to have a degree of imagination
rather than awaiting all of these events to actually play out since otherwise the move
will have already taken place by the time one is sure. Market timing and risk
management become key in profiting from such developments.
One should note also that for now there is a strong relationship between equities and
the dollar index.
Equities (SPX) vs even-weighted dollar index
For now still more driven by risk than interest rate spreads. Correlations do change over time.
If we look at the relationship between EUR/USD and interest rate differentials, we can see that it is a bit tighter.
EUR/USD vs US/Germany 2y Spread
EUR/USD clearly influenced by interest rate differentials. Rally in Euro since last year was associated with sell-off in schatz and inflation fears.
So if I am right in my article elsewhere in the idea that the Eurozone can catch up to the slowdown in global growth, interest rate differentials could turn very much more supportive for the dollar.
Outlook for EUR/USD
•Depends on risk appetite overall
•Scope for pricing out rate hikes as periphery continues to deteriorate, particularly if
inflation concerns recede.
•Greece cannot possibly pay back its government debt.
•Nascent shift to radical right means that time is running out for EU integrationists.
Bailouts politically unpopular, and EU fiscal union seems very far away.
Last time crude prominent in news (May/Jun 2008)
How did it turn out last time? (Crude)
A little speculative froth?
Last time sentiment towards USA this bad? (Loss of prestige)
“America is the Great Satan”
US Consumer Confidence – still very weak
Despite improving labour market and a strong equity rally US consumer confidence remains remarkably weak. Historically this has been a good contrarian indicator (buy stocks when confidence hits depressed levels).
Vicious Cycle Turns Virtuous?
Why is Consumer Confidence weak? Perhaps because of elevated gasoline (and other commodity) prices. This has been a focus of much popular discontent towards the Fed.
Most bullish phase for commodities is abundant liquidity and relative weak growth. Ie crude is high because dollar is weak and because the effective Fed Funds rate is low. The effective Fed Funds rate is low in part because consumer (and business) confidence is weak. Headline and core inflation both currently low. Tightening in rental market (vacancy rate was 12%; now 9.5%, 2012 5%) implies pickup in the large OER and tenant’s rent component of CPI. Core inflation 1.8% by year end 2011 according to DB.
QE2 ends shortly. A pickup in hiring and spending would be associated with upward revisions to interest rate expectations, which would tend to support the dollar and weaken gas prices – which would tend to lead to improving consumer confidence.
Postscript (June 2015)
We did see a dollar rally and a sell-off in crude, and really the question is what happens from here. Angst about Europe is certainly in the price, and I wouldn’t suggest that it is appealing to focus bearish views on this region (one has to be bearish another currency to be bullish the dollar). Similarly, tight oil is now on most peoples’ radar screens, although I wouldn’t suggest we have seen the full extent of bullish-US economy implications from this development (even though other nations have also discovered tight oil that is potentially commercially exploitable).
I think from here the points about the relative international competitiveness of the US remain important. It simply isn’t the case that US workers cannot compete with Chinese workers until we are all earning 50 cents an hour because for certain reasons, mysterious and well-understood, US workers remain very much more competitive than many other workers (and in the meantime China is seeing very significant wage inflation).
Unemployment continues to fall, and soon enough (I happen to think rather soon indeed) we will start to see the implications for nominal wage growth. This will tend to be bearish US fixed income, which will lend interest rate support to the dollar. (Bonds will sell off not on news of the first hike, but well in anticipation of it. The Fed always follows the market).
The US has been called the Saudi Arabia of agriculture – it’s a very competitive producer in this domain. For the time being this hasn’t made much of a difference in recent years at a macro level because prices are not much more than 5% of the levels of the 1970s peak in real terms. Agricultural prices do experience profound swings over long periods of time. If I am right, we have a monster bull market coming, and this will be very positive not just for US farmers, but for the US itself. The reasons why are varied – Jim Rogers has set out some important reasons, but if I am right that we are early in a cooling period (I eagerly await your downvotes), then there will be implications over time for agricultural prices. The Year without a Summer did occur during the Dalton Minimum, and wasn’t an easy time for agricultural production. Conditions are different now, but is it truly the case that the output of the sun has no influence on crop yields in the modern era?
It does seem to me also that the US is beginning to regain its nerve. That’s really key, because without confidence entrepreneurs do not take the risk of starting new enterprises, and they do not hire people. Similarly, without courage in the political domain there can be no hope of addressing problems at their root – in many cases the origins of these things goes back many years. Often it is only when one truly has no choice that one is forced to confront problems and work on solving them. That is the lesson of the peripheral European countries that have amidst considerable hardship begun to take painful decisions to fix things, just as Germany did in 2002 when she was considered the sick man of Europe.
The dollar is overbought here – I wouldn’t buy it for a trade. But I doubt it will collapse against other currencies over the next few years.
Btw in case not clear, I certainly would not be long the broad usd here (nor the DXY, which is heavily eur weighted and the eur is hated for bad reasons), I think these arguments above hold in the medium term, particularly in as much as I don’t think the dollar will crash.
But in a long term bull market for a complex you see tremendous rotation. Sugar had two major bull markets in the 70s yet gold didn’t peak for many years later, long after sugar did. And it may be the same with the USD.
Possibly Asian currencies are next, although I have not been following markets closely. The global excess savings phenomenon and the conundrum was really a US excess liquidity phenomenon with the U.S. current account, FDI, and long term portfolio outflows being the counterpart of Asian reserve acquisition of UST. Given the impact of energy (today) and perhaps higher agricultural prices (in coming years) on the current account and also renewed private and public conservatism on national savings rates, and the impact of rising yields on the attractiveness of the dollar, we may see appreciation pressure on usd vs Asia ex japan. This will put pressure on reserves, and liquidation may support a trend of rising yields, which itself will tend to support the dollar.
This being said, the relative yield differential theme may be more supportive even for the EUR than the USD, so it becomes less of a pure USD trade at this point.
I will write more on this shortly, probably not on Quora.
Of course in purchasing power terms it is a different matter (see my answer on this). This certainly is one domain where it doesn’t pay to bet against the Fed. Rather than price stability, the Fed has obliterated the real value of the dollar against the cost of living in the past century odd since it was founded. I am not sure things are going to be very different in future.
Update March 2016: I am not bullish the dollar any more.