Bondad has written a great piece yesterday Rate Cuts Won't do Jack on the Fed and the economy. Last week, Davesparts wrote about the dollar in this diary last week. But let's look deeper the dirty little secret of the devaluation of the dollar.
We blame oil price increases on Iraq, copper prices on China and the Bushies claim low inflation on their great economic job. All three are substantially false - all three have as much to do with the US deficit and the devaluation of the dollar as they do for the blamed causes. What you say - explication below the fold.
Let's look at the dollar versus the Euro.
Date | Dollar | Euro |
01/02/01 | $1.00 | 1.056 |
01/02/02 | $1.00 | 1.1 |
01/02/03 | $1.00 | 0.95 |
01/02/04 | $1.00 | 0.80 |
01/02/05 | $1.00 | 0.73 |
01/02/06 | $1.00 | 0.84 |
01/02/07 | $1.00 | 0.76 |
The dollar has declined against the Euro every year except 2005. What does this mean to the US, you ask? Well, let's look at oil prices with the currency adjustment.
Date | Oil (Dollar/BBl) | Oil (Euro/BBl) |
01/02/01 | $30 | $31.68 |
01/02/02 | $22 | $24.2 |
01/02/03 | $33 | $31.35 |
01/02/04 | $33 | $26.4 |
01/02/05 | $51 | $37.23 |
01/02/06 | $67 | $56.28 |
01/02/07 | $56 | $42.56 |
The dollar price for oil has increased 87% since 2001 (the max price rise on this table is 123%) while the Euro price has only increased 34%. That means that every company in Europe has gained an advantage over every US company equal to 2 dollars for every three dollars of price rise. Any wonder why the European economy is booming. A weak dollar is great for US exporters all things being equal. But if your underlying costs are rising at a higher rate than your competitor, then the advantage gets weakened.
Now, look at copper
Date | Copper (Dollar/lb) | Copper (Euro/lb) |
01/02/01 | $0.80 | $0.85 |
01/02/02 | $0.75 | $0.825 |
01/02/03 | $0.50 | $0.475 |
01/02/04 | $1.15 | $0.92 |
01/02/05 | $2.1 | $1.53 |
01/02/06 | $2.1 | $1.76 |
01/02/07 | $2.5 | $1.8 |
Once again, the dollar price for copper has increased 212% since 2001 (the max price rise on this table is 320%) while the Euro price has only increased 125%. That means that every company in Europe has gained an advantage over every US company not just on oil but on copper too. All major commodities worldwide are priced on dollars - that means when the dollar decreases and prices increase other countries don't see the same price impacts.
But where does the dollar decline really help "the economy" No, not in import prices where everyone talks. The big winner - WALL STREET. The estimate is that 40% of revenues for non-financial S&P 500 companies are foreign derived. If we look at that, the dollar impact follows:
Date | US revenues (Dollar) | Foreign Revenue (Dollar adj.) |
01/02/01 | .6 | .38 |
01/02/02 | .6 | .36 |
01/02/03 | .6 | .42 |
01/02/04 | .6 | .50 |
01/02/05 | .6 | .56 |
01/02/06 | .6 | .48 |
01/02/07 | .6 | .53 |
The S&P has gotten an underlying 17% increase in earnings over the last five years. Considering that the S&P is shooting for high single digit - low double digit earnings return, the currency factor has handed a good annual 5% increase in earnings in several years. A number of studies show that the individual companies with greatest overseas earnings may not respond as well as the overall picture says they should (i.e., they should get even a bigger bump). But part of that has to do with how funds buy groups of stocks. The overall market loves to look at aggregate earnings numbers and bigger earnings help float all the boats.
The bigger point is that the Bushies are trapped by this change. To take the dollar back to parity with the Euro would mean a 13% drop in US dollar based earnings for the S&P 500 that goes along with that change. What would be the impact of that on US investment wealth? In addition, it would cause a similar decline in every investment by every hedge fund in foreign markets. What would that do to those funds?
So this helps explain the reason the administration has to pump liquidity into the system - if the sub-prime debacle ended up bringing rates way up, the dollar recovers. The dollar recovers, it's likely the fund get hammered and the market goes down on the earnings drop. Bondad's piece argued about real interest rates but remember that the markets look at rate spreads - the differential between fed rates and the interest for a class of ratings. Dropping the fed rates allows the rate spread to increase for sub prime without actually increasing the rate for the commercial paper. This increases the margin on those loans without any apparent increase in rates on such things as mortgages. This helps keep the dollar low by dropping the fed rates -without that the rates would increase and possibly support the dollar. That happens and then the administration is stuck with a failed adventure in Iraq and a sub 10,000 Dow. It's the deficit, economy and Iraq headed into '08. No way that is allowed to happen.
My concern is that the current administration may be pursuing a weak dollar not as a support to exporters but rather to keep from devaluing those off shore investments - to the detriment of the US economy. This is the economic rope-a-dope that goes along with the Iraq rope-a-dope to allow them to hang all the bad news on the next president.