Friday, May 29, 2009

US Dollar Forecasts

The outlook for the dollar looks uncertain. There are certain factors which have caused many to fear a sharp decline in the value of the dollar. Dollar bears point to factors such as:

Rising National Debt

US National debt has risen from 41% of GDP in 2008 to an expected 81% in 2018. Part of this rise in government borrowing reflects the cyclical downturn and the effect on tax receipts. But, the debt also reflects a structural deficit aggravated by an ageing population and health care commitments.

A rise in national debt doesn't have to cause inflation and a depreciation in the Dollar.

(There are many examples of countries with larger national debts who haven't experienced inflation. In recent years one could look at the examples of Japan, Belgium and Canada. These countries have all had national debt of over 100% without causing any significant inflation. Japan's debt has now exceeded 200% of GDP)

However, the US Treasury purchase of dollar bills to finance the deficit is putting downward pressure on the dollar. And many are fearful future rises in government borrowing will just be monetised causing the dollar to devalue. It is this monetisation of the national debt which is putting most downward pressure on the dollar at the moment.


There are some analysts who see the increase in money supply and purchase of treasury bills as evidence we will see inflation in the future. This inflation will reduce the value of the dollar. However,

  • This link is not as clear cut as some suggest - money supply and inflation

  • Also, current inflation trends in the US are very low. In fact consumer prices are actually falling causing deflation to be a bigger worry at the moment.

  • Interestingly in the great depression many feared inflation as a reason for the government not to spend more. Yet, the great depression led to a prolonged period of deflation
Interest Rates
The depth of the recession means that, according to the Taylor rule, the ideal US interest rate would be around -5%. This of course is not possible, but, it suggests 0% interest rates could be maintained for a longer time.

On the Positive side there are a few factors which could strengthen the dollar in future months.

Economic recovery. A panel of US economists tentatively suggest the US economy could recover by the end of 2009 and enjoy positive economic growth in 2010. This may lead to interest rates rising from rock bottom and if the US led a global economic recovery, the dollar would likely benefit.

Lower current account deficit. The current recession has gone some way to reduce the US current account deficit and reduce the trade imbalances which made the dollar susceptible to devaluation.

The dollar will always be shaky whilst the US treasury are purchasing Treasury bills to increase the money supply. But, the feared hyperinflation and collapse of the dollar does not look likely at the moment. There is still a reasonable chance the US economy could recover soon with only moderate / normal inflation rates. If this scenario did occur, the dollar could start to look attractive once more.

1 comment:

David said...

Does anyone remember the so-called 'toxic assets' the extent of losses in derivatives markets ? $400 T by some accounts. Is this the reason for lack of inflation because the increase in money supply is going to g failed financial system @ 0% ?