The U. S. Dollar – Quo Vadis?

Dr. Robert T. LeClair

Villanova University

John Cabot University

Rome, Italy

1-1-1999Austria (€)Belgium (€)

Denmark (ERM II)Finland (€)France (€)

Germany (€)Great Britain (£)

Ireland (€)Italy (€)

Luxembourg (€)Netherlands (€)

Portugal (€)Spain (€)

Sweden (SKr)

1-1-1999 1-1-2001Austria (€) Greece (€)Belgium (€)

Denmark (ERM II)Finland (€)France (€)

Germany (€)Great Britain (£)

Ireland (€)Italy (€)

Luxembourg (€)Netherlands (€)

Portugal (€)Spain (€)

Sweden (SKr)

1-1-1999 1-1-2001 5-1-2004Austria (€) Greece (€) Cyprus (€) [1/08]Belgium (€) Czech Rep.

Denmark (ERM II) Estonia (€) [1/11]Finland (€) HungaryFrance (€) Latvia

Germany (€) Lithuania (ERM II)Great Britain (£) Malta (€) [1/08]

Ireland (€) PolandItaly (€) Slovakia (€) [1/09]

Luxembourg (€) Slovenia (€) [1/07]Netherlands (€)

Portugal (€)Spain (€)

Sweden (SKr)

1-1-1999 1-1-2001 5-1-2004Austria (€) Greece (€) Cyprus (€) [1/08]Belgium (€) Czech Rep.

Denmark (ERM II) Estonia (€) [1/11]Finland (€) HungaryFrance (€) Latvia

Germany (€) Lithuania (ERM II)Great Britain (£) Malta (€) [1/08]

Ireland (€) PolandItaly (€) Slovakia (€) [1/09]

Luxembourg (€) Slovenia (€) [1/07]Netherlands (€)

Portugal (€) 1/1/2007Spain (€) Bulgaria

Sweden (SKr) Romania

Headlines

• “Dollar faltering after seven years as leading currency” -USA Today

May 30, 2002

• “Dollar’s Drop Shows Loss of Faith in U. S. Economy”

-Wall Street Journal (Europe)June 3, 2002

Headlines

• “Dollar hits 14-month low versus Euro” -Financial Times

May 28, 2002

• “There are signs that the U. S. primacy as an investment location is now under threat” -Financial Times

May 31, 2002

History of European Monetary Union

• Maastricht Treaty (2 Feb. 1992)• Single Central Bank: (1 June 1998)

– European Central Bank (ECB)– Frankfurt, Germany– www.ecb.int/home/

• Single European currency (“Euro”)

History of European Monetary Union

• Qualification standards:– inflation– interest rates– fiscal deficit– national debt

EMU Convergence Criteria

• Inflation: no more than 1.5% above avg. of three members with lowest rate

• L-T interest rate: no more than 2% above avg. of three members with lowest rate

• Fiscal deficit: no more than 3% of GDP (Stability & Growth Pact)

Eurozone Stability and Growth Pact Breaches, 1999-2009

EMU Convergence Criteria

• Inflation: no more than 1.5% above avg. of three members with lowest rate

• L-T interest rate: no more than 2% above avg. of three members with lowest rate

• Fiscal deficit: no more than 3% of GDP (Stability & Growth Pact)

• Govt. debt: no more than 60% of GDP

History of the Euro (€)

• Officially introduced: 1 Jan 1999

• Currency and coins introduced: 1 Jan 2002

• “Legacy” currencies (Franc, Mark, Lira, etc.) no longer legal tender after 28 Feb 2002

Euro vs. USA[Source: Wall Street Journal, 9/28/98]

Euro-11 USA

Population 290 million 267 million

GDP $8.2 trillion $8.6 trillion

% World GDP 19% 20%

% World Trade 19% 17%

Stock Mkt Cap $3.6 trillion $9.5 trillion

$ Value of the Euro (€)

• Quick Quiz:

• What would you have paid to buy one Euro (€) on January 1, 1999?– A. more than $1.00

– B. exactly $1.00

– C. less than $1.00

$ Value of the Euro (€)

• 1 January 1999: $1.1719

• 26 October 2000: $0.8228 (low)

• 1 January 2002: $0.8920

• 22 April 2008: $1.6018 (high trade)

• 24 April 2008: $1.5952 (high close)

• 23 May 2012: $1.2599

Dollar Value of the Euro (€)Date $ Value % Change

1 Jan 2002 $0.8920

1 Jan 2003 $1.0501 +17.70%

Dollar Value of the Euro (€)Date $ Value % Change

1 Jan 2002 $0.8920

1 Jan 2003 $1.0501 +17.70%

1 Jan 2004 $1.2582 +19.80%

Dollar Value of the Euro (€)Date $ Value % Change

1 Jan 2002 $0.8920

1 Jan 2003 $1.0501 +17.70%

1 Jan 2004 $1.2582 +19.80%

1 Jan 2005 $1.3569 + 7.90%

Dollar Value of the Euro (€)Date $ Value % Change

1 Jan 2002 $0.8920

1 Jan 2003 $1.0501 +17.70%

1 Jan 2004 $1.2582 +19.80%

1 Jan 2005 $1.3569 + 7.90%

1 Jan 2006 $1.1842 -12.73%

Dollar Value of the Euro (€)Date $ Value % Change

1 Jan 2002 $0.8920

1 Jan 2003 $1.0501 +17.70%

1 Jan 2004 $1.2582 +19.80%

1 Jan 2005 $1.3569 + 7.90%

1 Jan 2006 $1.1842 -12.73%

1 Jan 2007 $1.3203 +11.49%

Dollar Value of the Euro (€)Date $ Value % Change

1 Jan 2002 $0.8920

1 Jan 2003 $1.0501 +17.70%

1 Jan 2004 $1.2582 +19.80%

1 Jan 2005 $1.3569 + 7.90%

1 Jan 2006 $1.1842 -12.73%

1 Jan 2007 $1.3203 +11.49%

1 Jan 2008 $1.4704 +11.37%

Dollar Value of the Euro (€)Date $ Value % Change

1 Jan 2002 $0.8920

1 Jan 2003 $1.0501 +17.70%

1 Jan 2004 $1.2582 +19.80%

1 Jan 2005 $1.3569 + 7.90%

1 Jan 2006 $1.1842 -12.73%

1 Jan 2007 $1.3203 +11.49%

1 Jan 2008 $1.4704 +11.37%

1 Jan 2009 $1.4043 - 4.49%

Dollar Value of the Euro (€)Date $ Value % Change

1 Jan 2002 $0.8920

1 Jan 2003 $1.0501 +17.70%

1 Jan 2004 $1.2582 +19.80%

1 Jan 2005 $1.3569 + 7.90%

1 Jan 2006 $1.1842 -12.73%

1 Jan 2007 $1.3203 +11.49%

1 Jan 2008 $1.4704 +11.37%

1 Jan 2009 $1.4043 - 4.49%

1 Jan 2010 $1.4369 + 2.32%

Dollar Value of the Euro (€)Date $ Value % Change

1 Jan 2002 $0.8920

1 Jan 2003 $1.0501 +17.70%

1 Jan 2004 $1.2582 +19.80%

1 Jan 2005 $1.3569 + 7.90%

1 Jan 2006 $1.1842 -12.73%

1 Jan 2007 $1.3203 +11.49%

1 Jan 2008 $1.4704 +11.37%

1 Jan 2009 $1.4043 - 4.49%

1 Jan 2010 $1.4369 + 2.32%

1 Jan 2011 $1.3342 - 7.15%

Dollar Value of the Euro (€)Date $ Value % Change

1 Jan 2002 $0.8920

1 Jan 2003 $1.0501 +17.70%

1 Jan 2004 $1.2582 +19.80%

1 Jan 2005 $1.3569 + 7.90%

1 Jan 2006 $1.1842 -12.73%

1 Jan 2007 $1.3203 +11.49%

1 Jan 2008 $1.4704 +11.37%

1 Jan 2009 $1.4043 - 4.49%

1 Jan 2010 $1.4369 + 2.32%

1 Jan 2011 $1.3342 - 7.15%

1 Jan 2012 $1.2957 - 2.89%

Euro (€) versus the U. S. $[Interbank Rate – 1/1/99 to 5/1/12]

Who Needs Dollars?

• People who want to …– buy U. S. goods and services

– invest in U. S. assets

– travel to the U. S.

• Anyone who wants to buy oil!

Why the weak Euro (€)?Why the strong U. S. Dollar ($)?

1. Stronger U. S. economic growth

2. Shrinking U. S. Government deficit

Why the weak Euro (€)?Why the strong U. S. Dollar ($)?

1. Stronger U. S. economic growth

2. Shrinking U. S. Government deficit

3. Strong U. S. stock market performance; compound annual returns for ten years ended -

2001: +13.00%

2002: + 9.34%

2003: +11.07%

2004: +12.07%

2005: + 9.07%

What’s Changed to Weaken the $?

• Slower U. S. growth

U. S. A. GDP Growth (%), 1993 - 2012

What’s Changed to Weaken the $?

• Slower U. S. growth

• Large U. S. government deficits

U. S. Budget Deficit/Surplus[1990-2012, $ Billions]

What’s Changed to Weaken the $?• Slower U. S. Growth

• Large U. S. Government deficits

• Weaker U. S. market returns (S&P 500):

2000: - 9.1% 2006: +15.8%

2001: - 11.9% 2007: + 5.5%

2002: - 22.1% 2008: - 37.0%

2003: +28.7% 2009: +26.5%

2004: +10.9% 2010: +15.1%

2005: + 4.9% 2011: + 2.1%

What’s Changed to Weaken the Dollar ($)?

1. Slower U. S. economic growth

2. Large U. S. Government deficits

3. Weaker U. S. stock market performance; compound annual returns for ten years ended -

2002: + 9.34% 2007: + 5.91%

2003: +11.07% 2008: - 1.38%

2004: +12.07% 2009: - 0.95%

2005: + 9.07% 2010: + 0.50%

2006: + 8.35% 2011: + 2.91%

Compound Annual Returns, S & P 500[Ten-Year periods Ending 2001-11]

P/E Ratio, S & P 500 Index (TTM)[Monthly, 1/1/02 – 6/1/12]

Political Effect?

• U. S. Treasury Secretaries:

• Robert E. Rubin(1995-1999) – “strong dollar”

• Lawrence H. Summers(1999-01) – “strong dollar”

• Paul H. O’Neill(2001-02) – “market decides the value of the dollar”

• John W. Snow(2003-06) – “A strong dollar is in the national interest.”

Political Effect?[U. S. Treasury Secretaries]

• Henry Paulson (2006 -2009) – “As I think you know, I believe very strongly that a strong dollar is in our nation’s interest, and I’m a big believer in currencies being set in a competitive, open marketplace.”

Political Effect?[U. S. Treasury Secretaries]

• Timothy Geithner(2009 - ) – “A strong dollar is very important to this country, I mean that, and it’s very important that people recognize it. It does bring special responsibilities and burdens on the United States and it’s very important that we make not just Americans but make the world understand that we are going to go back to living within our means.”

Achilles Heel?[Financial Times, May 31, 2002]

• “The Achilles heel of the US dollar has been the bulging current account deficit, which is expected to reach $465bn (€516bn) this year.”

U. S. Current Account Deficit[1998-2012, Quarterly, ($ Billions)]

Achilles Heel?[Financial Times, May 31, 2002]

• This means the US needs to attract $1.3bn in overseas funds every day to prevent the dollar from falling.”

U. S. Avg. Monthly Net Capital Inflow ($Billions, 2001-2002)

Financial Times , Friday, May 31, 2002

44

14.6

2001 2002

Year

Where Do We Go From Here?

• “Dollar slips to all-time low ($1.3667) vs. Euro”

– Associated Press– December 31, 2004

• “Bears are betting on a decline in the dollar.”

– Barron’s– August 21, 2006

Foreign Trade (-) and Capital Flows (+)[2005-2012; $ Billions]

Foreign Trade (-) and Capital Flows (+)[2005-2012; $ Billions]

Foreign Holdings of U. S. Treasury Securities

Source: U. S. Treasury International Capital (TIC) Reports, monthly

[www.treas.gov/tic/mfh.txt]

Total Foreign Holdings of U. S. Treasury Securities, $Bils., 2005-12

Increase of$3.2 Trillion

Chinese Holdings of U. S. Treasury Securities, $Bils., 2005-12

Japanese Holdings of U. S. Treasury Securities, $Bils. 2005-12

“Oil Exporters” Holdings of U. S. Treasury Securities, $Bils., 2005-12

Top Ten Foreign Holders of U. S. Treasury Securities, $Billions., - March 2012

Concerns About the US Economy?

1. Corporate governance and accounting standards (Enron; WorldCom; Countrywide Mortgage)

2. Productivity gains have not translated into higher corporate profitability

3. Surge in government spending …could depress economic growth

Impact of a Weaker U. S. Dollar[Disadvantages]

1. Foreign goods more expensive2. Foreign investment more

expensive3. Foreign travel more expensive4. U. S. interest rates – higher; less

foreign capital

Impact of a Weaker U. S. Dollar[Advantages]

1. American products are more competitive abroad; increased exports; lower U. S. trade deficit

2. U. S. A. manufacturing sector more competitive

3. Increased return on U. S. overseas investments

Return on Overseas Investments

$ Value of the Euro (€)

Euros

Earned

Dollar

Equivalent

$0.95

($1 / €1.053)€ 1,000,000 $950,000

Return on Overseas Investments

$ Value of the Euro (€)

Euros

Earned

Dollar

Equivalent

$0.95

($1 / €1.053)€ 1,000,000 $950,000

$1.00

($1 / €1.000)€ 1,000,000 $1,000,000

Return on Overseas Investments

$ Value of the Euro (€)

Euros

Earned

Dollar

Equivalent

$0.95

($1 / €1.053)€ 1,000,000 $950,000

$1.00

($1 / €1.000)€ 1,000,000 $1,000,000

$1.35

($1 / €0.74)€ 1,000,000 $1,350,000

Where Do We Go From Here?

• “OFF THE CHARTS; Dollar Sinks the Lowest Since It Started to Float”

– The New York Times

– September 22, 2007

• “Fear of European Slump As Currency Sets Record”

– The New York Times

– September 22, 2007

Where Do We Go From Here?

• “As Dollars Pile Up, Uneasy Traders Lower the Currency’s Value”

– The New York Times– May 23, 2009