Letters by a modern St. Ferdinand III about cults

The US$ will most probably recover in 2005 for some sound economic reasons: high productivity, high corporate returns, a 4 % GDP growth, declining budget deficits and a $30-35 Oil price per bbl. However many experts feel that the US $ must still devalue to close the trade deficit, and reflect economic weakness in Japan and Europe. Such views have wide media coverage. They are however completely wrong and as usual, completely negative.

Many ‘experts’ state that from its recent peak in May 2004, the dollar which has plummeted 15 percent against the euro, will likely remain soft and decline. "The dollar slide that began in 2002 is likely to continue, especially if, as we expect, the US current account deficit (the broadest measure of the trade gap) hits a new record and US capital outflows pick up," so says Citigroup chief economist Kermit Schoenholtz.

This school of U$ pessimism believes that the deeper the trade deficit, the more the US economy goes into debt. To narrow the shortfall, either the dollar must slide or interest rates on US investments must rise to lure investors. In 2003, the current account deficit broke above 500 billion dollars for the first time. In 2004 the trade deficit was $412 billion. These assessments are however wrong. Far more critical to the health of the US$ is the budget deficit which should be significantly reduced in 2005 giving the $ a major boost.

For the US economy, the dollar slide is not all bad. "Made in USA" exports are now comparatively cheaper for foreigners, supporting production in the United States. US companies in the Standard and Poor's 500 index are likely to boost operating earnings per share by 4-6 percent in 2005 after double digit gains in 03 and 04 [22 %]. Part of their increased profitability is linked to foreign markets and exports. Though lower than in ’05, the increase in US corporate earnings still outstrips all of its trading partners and will only rise as US productivity and cost restructuring make US firms more competitive.

It is unlikely as well that Asian, Japanese or European central bank authorities will intervene in foreign exchange markets. There is not much point in foreign governments artificially boosting the U$, even in Asia which needs the US as an export market. The actual power of intervention by governments to stabilize currency flows is minimal compared to the market based currency trading and investment funds. There is no reason to suppose that government intervention would significantly alter longer-term currency trends or open market fundamental assessments of where currencies are heading.

Importantly the US will increase its interest rates in 2005 and decrease its money supply. This will stop the cheapening of the U$. Given economic growth and inflationary pressures higher interest rates are necessary and will attract capital. The slow increase in rates will not affect the housing market since interest rates are still near 40 year lows. Housing starts and prices will still rise by 4-6 % in 2005 and there is no need to term such an increase a ‘bubble’. It is hard to rationalize how a market that increases 6 % on average per annum is suddenly a bubble. Concomitantly the US will keep cutting taxes which increases disposable income and coupled with rising productivity, a still-accommodative interest-rate policy and a gain in net jobs, household incomes will only increase further sustaining US GDP growth.

The media overplays even the so-called ‘political risks’. The Yuan-US$ relationship is important for both countries and the Yuan will not be revalued anytime soon. Fifty percent of Chinese exports to the US are by US Multinationals complicating trade deficit analysis and political response. The benefits to US consumers of offshore production are obvious and in general there is no threat in having a trade deficit with China. In fact in the longer term an industrializing and political pluralist China will be a boon to the US economy. Given inflationary pressures now existent in the US economy with an inflation rate of about 2.5 %, most people should welcome increased importation from China of cheaper, better product. [The chief inflationary component is of course oil and energy prices and these will decline as oil supplies stabilize and new reserves are found and exploited.]

In general the US $ which needed to revalue itself against the euro after an artificial run up in the 1990s will experience a renaissance of value, if the Bushites slash the US budget deficits and if [and when] oil prices fall. Spending reduction will ease market concerns about fiscal imbalances and coupled with a US economy that will outperform in every economic fundamental Canadian and European markets, the US$ in 2005 should rise by 10-15 % in value.