Monday, June 28, 2004

The US dollar's gravity-defying feats seem to be wearing thin.

Agence France Presse reports today that "Dollar sinks against sterling," which in and of itself isn't really newsworthy. Taking a longer-term view of the USD, however, reveals some interesting trends at work.

First a microhistory of the dollar. The USD, as measured by the real broad dollar index, hit its post-Reagan low in July 1995. From that point on to February 2002, the USD rose partly on the back of robust US economic growth compared to the rest of the world, but mostly in two big spurts -- in 1997 as a result of the safe-haven status of the US for capital flight and central bank reserves, and in 2000-01 as a result of the US-centric global boom. The dollar reached its peak in February 2002, rising 34% in real terms over seven years.

From February 2002 to January 2004, however, the USD sank in three waves (Feb-July '02; Oct '02-June '03; Aug '03-Jan '04), giving up all its ill-gotten post-East Asian financial crisis gains. The real broad dollar lost 13% over nearly two years, and the real major currencies index dropped 24% over the same period.

The third swing of the dollar since 1995 was back upwards -- +5% from January-May 2004. Since May 10, however, the fourth wave has taken over with a vengeance. Since May 13 the broad dollar index is down 2.4%; the major currencies index dropped 4%.

Rather than see the trials and travails of the USD since January 2004 as independent "swings", however, perhaps we should instead see it as simply the fourth "wave" in the secular downward trend of the dollar since February 2002. In light of the massive US current account deficit, now back over 5% of GDP, and global interest in US government debt as the main pillar holding the dollar up in face of this deficit, there is every reason for the USD to fall even further in the future.

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