Back in the 1970s a market commentator used the term ‘Thin Reeds’ to describe an event, not yet clearly visible, which could be a big surprise in the future.
One surprise today could be the sustained decline in the dollar. The dollar has been weak this year (see chart below). Over the past six months the dollar is down (4%) against the Chinese renminbi, (6%) against the Canadian Dollar and (6 ½%) against the Euro.
In one sense a weak dollar is a good thing. It makes our exports more affordable and our imports more expensive which could be a benefit to domestic producers. But in general a sustained weakness in the dollar is a bad thing. The US dollar is the world’s reserve currency. More countries hold more reserves and government securities in dollars than any other currency. They see the dollar as stable in value and a safe harbor in the storm. If the dollar loses its status as a reserve currency, interest rates will rise and the U.S. economy will suffer.
The value of the dollar depends on many factors. Currency forecasting is an art not a science. In general if you have higher interest rates than others, you will attract investment and your currency will appreciate. The same goes for economic activity. If your economy is growing faster than others more money will come your way, driving up the value of your currency. Right now the US is suffering on both scores. The Fed has pushed interest rates down to almost zero on the short end and has said they intend to keep rates there for an extended period of time, maybe up to two years. If foreigners can get better returns elsewhere the value of the dollar will suffer.
On the economic front the U.S. has not done a good job controlling COVID. The economy has not bounced back as rapidly as it has in China and other Asian countries. We have a stop and go recovery now which is negatively influencing foreign investment here. This does not help the value of the dollar.
Stephen Roach, the former market strategist at Morgan Stanley and now a faculty member at Yale, is someone worth listening to. He sees the decline in the dollar going further today maybe even becoming a crash. So much of economics is based on confidence. As long as the world continues to see you as strong, no need to worry. But as soon as the world fears ‘the King has no clothes’ then watch out.
Right now the government is borrowing enormous amounts of money which has to be supplied by either the U.S. public or foreigners. The budget deficit is expected to be 16% this year. It will narrow next year, but maybe ‘only’ to 8.6%. In addition the US is still importing far more than it exports. The dollar needs a lot of foreign friends. Will we have a ‘King has no clothes’ moment? Our guess is we are safe for now but the dollar is a Thin Reed we need to keep a close eye on.
