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Is The Dollar Excessively Overvalued?

 October 12, 2010 10:01 AM

Naked Capitalism's Yves Smith pointed to an Oct 10 2010 article written by Tim Duy  as a "must read." Coming as it was from Yves, I made it a point to read it first thing. Here is the link:


Tim Duy's argument contends that "an excessively high dollar is the explanation for the simultaneous existence of a sizable current account deficit and excessive unemployment." I hadn't thought of that before but it intuitively makes sense. He then goes on to claim that "foreign central (banks) repeatedly acted to limit dollar depreciation." Yes, Most notably with Mexico 1994, Asian tigers 1997 and Russia 1998.

Duy states all of these observations with the dollar now below 80 cents. The only time the dollar has ever been below 80 cents was in the the first half of 2008, the 2nd half of 2009 and 2H 2010. 80 cents is the level at which the dollar repeatedly found support in the 1990s (1991,1992,1995) following the 1985 G-5 Plaza Accord and once again in 2004. The strengthening of the dollar in 2005 came about roughly 9-12 months after jobs began to be created in the US. A dollar devaluation may be the best hope for the US to create jobs again. It certainly was a contributing factor to job growth in 2004.

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The dollar had to persistently decline from 2001 through 2004 before jobs began to be created following the last recession.

Duy continues:

"Currency depreciation - of substantial magnitude - is a mechanism by which economies recover from financial crisis. But we shouldn't underestimate that challenges that accompany such an adjustment. If it happens to quickly - a sudden stop of capital - the most likely short run outcome is that the current account deficit will be resolved with import compression via a sharp drop in demand. This would be painful, to say the least.
Neither, though, is the current path - a painstakingly slow Dollar depreciation. The result so far is persistently high US unemployment, with no relief in sight." QE2 is coming with a vengeance on Nov 3. Notes Duy, taht is the date the Fed is positioning "to declare war on Bretton Woods 2." QE2, Duy asserts, will be a de facto "attack on the strong dollar policy."

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That attack (war) is already well underway. It began when the Fed announced its QE2 intentions on Aug 10 2010. The announcement was akin to broadcasting to the rest of the world that you had a bazooka in your pocket and were preparing to launch a few rounds from it. They telegraphed their intentions and are giving mkt participants about 3 months to get positioned for it (assuming Nov 3 is when QE2 gets underway).

I myself have been underestimating the impact and aim of QE2. I dismissed it as just another QE1. But I probably underestimated the aim of QE1 to drive the dollar down as well. The aim of QE1 to drive the dollar down you see, was disrupted by the series of potential sovereign default crises in Dubai and throughout Europe at the end of 2009 and the first half of 2010.

Fact of the matter is this: QE1 was announced on March 18 2009. The dollar decline from March 2009 to Nov 2009 (dubai world interrupted the dollar decline)was not quite disorderly but it was the most rapid decline I have ever seen and was worse than the dollar decline following the 1985 G5 Plaza Accord.
The dollar destruction that got underway in March 2009 resumed in June 2010. And guess what? The dollar decline following the June 2010 high has had an even more rapid than the dollar decline following the March 2009 high. The dollar decline off the June 2010 can not yet be characterized as disorderly either.

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