By Lei Xuan
“The world is in a currency war,” says A. Gary Shilling, president of the New Jersey-based consultants A. Gary Shilling & Co.
His reasoning is simple and global: “Many central banks are chopping interest rates to push their currencies down. They all hope to spur exports to offset internal weakness.”
A moderate depreciation of currency is, indeed, especially good for countries who rely heavily on exports. A weaker currency makes export goods cheaper in foreign markets.
While overseas firms benefit from currency depreciations, some U.S. companies have been hurt by appreciation of the dollar. U.S. firms from McDonald’s Corp. to Apple Inc. all reported shrinking or lower-than-expected overseas revenues when they converted foreign currencies into the dollar.
But Americans still benefit at places like the gas pump.
“The dollar is the global reserve currency,” says Adolfo Laurenti, managing director and chief international economist of Mesirow Financial. “Import goods, such as commodities and energy, are priced in dollars. They get cheaper as the dollar strengthens, which is good for U.S. households.”
Economists believe some of the money saved from falling energy prices will be spent to bolster other sectors in the economy.
A New Currency War?
In recent months, the European Central Bank launched quantitative easing, a monetary policy that purchases financial assets from commercial banks to increase the amount of money in financial markets. The QE program has made the euro further depreciate about 2 percent against the U.S. dollar in one month.
Australia, India, Canada and Denmark cut interest rates in tandem to boost their economies. Those countries’ currencies all devalued against the U.S. dollar as well.
When so many countries try to devalue their currency, “the competitive devaluations offset each other. Nevertheless, all are devalued against the U.S. dollar, which, as the world’s currency, can’t devalue,” Shilling says.
“Currency war” has become a buzzword since former Brazilian Finance Minister Guido Mantega used the term in 2010. He adopted it to describe a condition when countries compete with each other to hold down their currencies and gain an advantage in global market.
However, this time, some experts believe central banks are motivated by a different agenda.
“I do not use the term ‘currency war’ because it signals an intent to do harm, and that is not the intent,” says Bluford Putman, managing director and chief economist of CME Group. “Quite a few countries are seeing declining inflation and in some cases, the potential of deflation. Cutting rates is quite appropriate for domestic purposes.”
Relatively strong economies will attract global capital flows, and the U.S. dollar’s strength reflects the relative health of the U.S. economy, experts say.
“Relatively weak economies and accommodative monetary policy may lead to depreciating currencies, but it is not currency war,” Putman says.
What does a strong dollar mean?
The U.S. economy is recovering on several fronts. The U.S. GDP in 2014 recorded a 2.4 percent growth, the strongest year since 2010. The unemployment rate was 5.7 percent in January, just slightly above the 5.2-to-5.5 percent level, which the Federal Reserve views as normal.
The U.S. economy is in much better shape than the rest of the world. Europe is still trying to pull out of stagnation. Japan temporarily rolled back into recession in the second and third quarter of 2014. Investors show confidence in the U.S. economy and thus turn U.S. dollar to be a safe-haven currency.
“In general, having a sound currency is a very good idea,” says Dr. Phil Levy, senior fellow on the global economy for the Chicago Council on Global Affairs. “It is better than people worrying about losing its value.”
However, the appreciation of the dollar also means “the U.S. exporters are going to face more challenges,” according to Levy.
Levy points out that the 2014 fourth quarter of U.S. GDP growth missed forecasts at 2.6 percent, compared to second quarter 4.6 percent and third quarter 5.0 percent growth rates.
Weak exports partly drove the slowdown. Exports could fall even harder since the dollar is still advancing against most of the foreign currencies. Nevertheless, it should also be noted, as a sign of economic recovery, consumer spending, which accounts for two-third of the U.S. GDP, increased at a fast pace at 4.3 percent, the best performance since the first quarter of 2006.
“I think the U.S. economy is doing relatively well,” Levy says. “The drag comes from the slow growth from the rest of the world.”
U.S. economy 2015
Could the U.S. economy sustain solid growth in 2015 without being dragged down by the relatively weak global economy? All eyes are set on Federal Reserve’s monetary policy now.
While other central banks are cutting interest rates, the Federal Reserve is expected to raise interest rates sometime between June and December. An interest rate hike will show the Federal Reserve’s confidence on the U.S. economy and decrease the amount of money in the financial market. It will drive the dollar even higher.
In January, the Federal Reserve told the public it would be “patient” in deciding when to raise interest rates. The Fed has an “increased concern about the global economic outlook,” as well as “the announced and anticipated foreign central bank policies.”
“There are two ways we can think it (international development) may affect the Fed’s action,” says Levy. “One way, you can say [other countries] are driving down their currencies. We need to respond. I think that’s very unlikely. The other one is, they are loosening their monetary policy. Therefore, their economy revives, which means there will be a greater demand in the world, so that we can go ahead our plans. I think that’s more likely.”
Experts are generally optimistic about the U.S. economy. Whether or not they see a currency war, they all agree that the depreciation of other currencies won’t stop the U.S. economic recovery because the main driving force of the U.S. economy comes from domestic factors.
“The strong dollar doesn’t affect the American economy much,” says Shilling, “U.S. exports are only 13.5 percent of the GDP, the lowest of all G7 and BRIC countries except Brazil.”
Unless there is a geo-political crisis in Ukraine or Middle East, or a major financial crisis in Europe or Asia, Laurenti says he doesn’t think the global market will pose a big threat to the U.S. economy.
“While the U.S. economy is more integrated with the global economy than it used to be, most of the strength we anticipate in 2015 is based on domestic factors, so U.S. growth should not be too dependent on developments abroad,” he says.