US growth is strong relative to much of the developing world, which makes it attractive to capital seeking higher growth rates. And, the US Central bank is raising rates, so it is attractive from a relative interest rate perspective.
On the other hand, the US $ has declined a great deal vs some major trading partners over the last 40 years. In the 1970s, a dollar bought up to 360 Yen; now it buys 110. In the late 1980s, one US$ could buy 10 and even 12 Renminbi on the black market; now a dollar buys 6.5 Renminbi. Over the long-term, countries with high savings rates and current account surpluses tend to see their currency rise relative to countries with low savings rates and large current account deficits (who must fund their spending by importing capital from abroad).
The US Current Account is still in the red (though much smaller than several years ago), and US savings numbers have improved. That said, remember that currencies are a relative value investment. Compared to thrifty East Asia, the long-term US numbers are not as attractive. The fundamentals for the rest of the world relative to the US are not as crystal clear.
The US currency is also affected in the short-run by both current political policy and the business cycle. Trade wars and ballooning public deficits don’t inspire confidence among foreign investors. And if foreign investors choose to keep their money at home, it would cause the US $ to decline and US interest rates to rise.
Inflation and higher interest rates are the other related factors that will impact the US $ in the near term. As noted above, higher relative interest rates and relative growth rates have attracted foreign capital to the US. But if there is the perception that these higher rates of growth and yields are being eroded by uncontrolled inflation, and that the Federal government cannot control its spending and the Fed is behind the curve, foreigners will reduce their US investments. Inflation, when it is perceived to be too high, will cause a currency to lose value, because it destroys purchasing power. Unfortunately, trade wars as well as a decline in the US $ can further exacerbate inflation by making imports more expensive. To date, we have not seen a run on the dollar or inflation reach a dire tipping point that would drive interest rates up and asset values down, but the probability of this happening has increased.
Will the next 40 years look like the last 40 years for the US $? No one can know for certain. However, in an upcoming article, we will show how this gradual decline in the US $ has been one of the major benefits US $ investors have gained in the past by putting their money to work in foreign equities.
This article was written by Kent Peterson, PhD (author of the blog: Insights from a Quant), Joe Mallen, and Chris Shuba of Helios Quantitative Research, a participant in the ETF Strategist Channel.
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