Column

THE SICK GREENBACK

As the dollar’s troubles worsen, watch China and its currency. Then watch gold.

DONALD COXE March 10 2003
Column

THE SICK GREENBACK

As the dollar’s troubles worsen, watch China and its currency. Then watch gold.

DONALD COXE March 10 2003

THE SICK GREENBACK

As the dollar’s troubles worsen, watch China and its currency. Then watch gold.

Column

DONALD COXE

THAT THE AMERICAN dollar would enter a major bear market was inevitable, because the U.S. has long been deeply uncompetitive in international trade. America has enjoyed a current account surplus only once in the past 14 years: during the previous Gulf War, such oil states as Saudi Arabia and Abu Dhabi contributed to the costs of the war, and such pacifist states as Germany and Japan paid the U.S. billions of dollars rather than supply troops.

That mercenary approach to war won’t happen this time, because even those states eager to get rid of Saddam (most of the world except, possibly, France) are now willing only to hold the U.S. coat and hold their noses.

How overvalued is the U.S. dollar? The nation’s trade deficit was US$40 billion in November and US$44.2 billion in December. Add in short-term capital flows, and the world’s biggest economy is hemorrhaging five per cent of GDP. The trade deficit averaged more than US$1 billion per working day in the late 1990s, but now exceeds US$1.75 billion—the rough equivalent of 115,000 Toyota Corollas a day.

The reason the greenback doesn’t collapse from non-stop bleeding is that it is the world’s pre-eminent financial currency. As American consumers send money abroad to buy the things that define The American Way of Life, foreigners don’t dump those dollars: they invest them in what has been the most dynamic economy in the industrial world, buying U.S. bonds, stocks and real estate. More importantly, they pour untold billions of those dollars into the great global parking space—the Eurodollar market.

Eurodollars are dollars deposited in banks anywhere outside the U.S. If you maintain an American dollar account with your bank in Canada, you are a Eurodollar holder. That puts you in the same game with global corporations, governments, dictators, drug lords, and millions of people around the world who feel comfortable holding short-term deposits in the world’s most liq-

uid and acceptable currency. You—and they— are at risk in the dollar bear.

Since the American dollar went on a tear in the late 1990s, the buildup in Eurodollars has apparently been enough to maintain a currency bull market despite the worsening trade deficit. I say “apparently” because no one counts Eurodollars, although most international economists agree they are the world’s biggest pool of financial liquidity.

A big percentage of that Eurodollar pool is lent by banks abroad to American banks. They use this money to finance loans and mortgages, supporting The American Way of Debt. Bridgewater Associates estimates that the U.S. is tapping more than 70 per cent of all cross-border savings in the world to finance its current account deficit and keep the economy from plunging into recession.

Stein’s Law says, “If something cannot go on forever, it will stop.”

The U.S. dollar defied Stein’s Law for years because the U.S. stock market defied it, drawing in hundreds of billions of dollars to buy those glamorous tech stocks that were building what was known as the New Economy. Foreigners proved to be as gullible as Americans in believing that companies with no real earnings (after accounting for stock option costs) were worth trillions.

When reality hit Nasdaq—like an anvil— the U.S. went into recession, and the days of dollar glory were numbered. At the moment, what prevents a vertiginous plunge is that the two heavyweight alternatives to the dollar—the euro and the yen—give the holder the right to participate in two of the world’s most unappealing economic zones.

When a country’s currency is overvalued,

How overvalued is the U.S. dollar? Every working day, the trade deficit exceeds US$1.75 billion—or about 115,000 Toyota Corollas.

and its factories and farms suffer, that currency should fall to a level that restores competitiveness. That’s Economics 101.

It’s not working this time. The U.S. trade deficit has been worsening along with the value of the dollar. In part this is due to the normal lags that attend a currency revaluation. Because of orders made far in advance across the globe, it can take from six months to two years before the full effects of a currency drop show in the trade account.

But this time, something even more challenging is hitting the beleaguered U.S. economy. China will not let its currency— the renminbi, or yuan—float in global markets. It pegs it to the value of the U.S. dollar. Result: when the dollar falls 20 per cent against the euro, 10 per cent against the yen and six per cent against the loonie, so does the renminbi.

China, the world’s most formidable export force and the biggest contributor to the U.S. trade deficit, gains global market share as the greenback tries to reach the equilibrium that will let America compete. (In the past 12 months, the U.S. has lost 439,000 manufacturing jobs; since the dollar bull market began in 1995, more than three million factory jobs have migrated abroad.)

Major currency bear markets take years, and always end in overshoot, in which the currency becomes seriously undervalued. That’s what happened to the eurozone currencies after 1995, when they fell more than 40 per cent against the dollar. Their successor, the euro, has recently recouped roughly one-third of that loss, and will probably regain the rest in the next two years.

The industrial world will not forever let China continue to gain global share by suppressing its currency. Japan did that in the 1970s, keeping its yen in the 250 range to the dollar, before the industrial nations eventually gave Japan a choice: we’ll erect high walls against your exports unless you float your currency, giving our producers a chance. The yen soared as much as 60 per cent.

Expect the G7 to impose currency fairness on China. When China’s currency floats, the dollar’s bear market will intensify, and gold prices will shoot skyward.

Stein’s Law always wins. It just takes time.

Donald Coxe is chairman of Harris Investment Management in Chicago and of Toronto-based Jones Heward Investments. dcoxe@macleans.ca