America is a patriotic place. We're proud of our heritage. We like to win.
So it's not surprising that we view the strength of the U.S. dollar as a proxy for our national standing. When it's up, the world is elevating us. When it's down, something's not right.
But that's not how the financial markets view it. Since the dollar is the global reserve currency, the dollar acts as an inverse for confidence. When people feel good about the global economy, the dollar tends to drop.
But if the United States is ever going address the global imbalances that got us into this economic mess (an overly large trade deficit, over-reliance on debt and excessive dollar reserves in China and elsewhere), the dollar will need to weaken substantially.
Yes, that means pain: rising prices and lower wages, which will be hard pills to swallow. But here's why we need to take our medicine -- and how to ease the pain.
Benefits of a falling dollar
Put simply, a dollar that's worth fewer euros or yuan would make the goods we make more attractive around the world and attract foreign investment in new factories here.
And there's more. A weaker dollar would discourage, as it has recently, the Chinese from buying dollars to artificially hold down the value of their currency. Up till now, the positives from this have benefited both sides. We gorged ourselves on cheap imported goods and cheap imported credit, while the Chinese put millions to work and accumulated trillions in stockpiled dollars.
Anthony Mirhaydari
Now, the negatives are being felt. Economists, including Federal Reserve Chairman Ben Bernanke, have warned that the flood of cheap money from China and elsewhere has overwhelmed the ability of our financial system to allocate savings to good investments that will grow the economy. Instead, as we saw during the housing bubble, it shoved cash into bad investments in inflated assets that blew up in our faces.
For their part, the Chinese have been battling with excessive inflation and their own bad investment, an over-reliance on exports and overbuilding of factories and other infrastructure. That, along with some negative attention during the presidential election, courtesy of Mitt Romney, has encouraged Beijing to push the Chinese yuan to new highs against the dollar.
So we're moving in the right direction.
Necessary pain
The dollar is getting cheaper, especially relative to the Chinese currency, and the negatives from this are starting to emerge. Americans will find imported goods, including crude oil, becoming more expensive while their take-home pay remains stagnant. Travelers will find less-favorable exchange rates. And cheap credit will be a little less pervasive.
Yet, if we're going to turn this thing around -- and address structural deficiencies like an employment-to-population ratio that hasn't been seen since the early 1980s, lost manufacturing jobs (shown above) or an annual trade deficit of nearly $600 billion (shown below) -- more must be done.
That's because, as new research by the Boston Consulting Group shows, with rich world economies struggling under aging populations, fiscal deficits and excessive debts, the driver of economic growth globally is going to be in the emerging middle class in countries like China and India.
My recent columns have focused on "supply side" solutions for our economic malaise. These include encouraging businesses to hire and invest and boosting two critical metrics of prosperity that have slowed: labor productivity and gross domestic product per capita. (Read, for example, "Is this economy a lost cause?") This discussion, along with my recent comments on catering to the rich here at home, is the demand side of the equation.
It boils down to this: The government needs to find ways to encourage businesses to cater to wealthy consumers at home and the newly wealthy overseas. And by boosting the price competitiveness of exports, a weaker dollar will contribute to this.
Consider how our trade deficit started to stabilize in the mid-2000s after a large, sustained drop in the greenback.
The prize awaits
Some Boston Consulting Group researchers, led by Michael Silverstein, have elaborated on this strategy in a new book, "The $10 Trillion Prize," (find it on Bing) which refers to their projection that by 2020 the combined consumer market of China and India will total that amount -- which is nearly equivalent to current levels of annual spending by American consumers. By then, there will be nearly 1 billion middle-class consumers in those two countries.
The BCG team believes that lower U.S. labor costs and cheap domestic energy could create up to 5 million jobs by 2020 via rising exports.
BCG survey data show a confident, positive, and aspiring group of people. Some 36% of Chinese and 19% of Indians expect to increase their discretionary spending over the next 12 months, compared with only 11% of Americans, 8% of Europeans and 5% of Japanese. They are also looking to "trade up" to better-quality goods.
This is where we fit in. According to the surveys "Made in USA" is associated with quality and luxury and is an aspirational label for the newly affluent and brand-conscious in Asia. Chinese and Indian shoppers care quite a bit about image and brand. This is a great opportunity for marketing-intensive U.S. companies selling premium products.
Already, more than 60% of Chinese consumers say they are willing to pay more for "Made in USA," and more than half had chosen a U.S.-made product over a less-expensive Chinese good at least once in the month before the survey.
Dollar already dropping
The good news is that we're on the right track. With Greece getting another deal to cut its debt load this week, Europe looks a little less vulnerable to economic collapse. That's boosting the euro and dropping the dollar. If Washington can get a short-term extension on the fiscal cliff done -- as looks likely -- that will add further downward pressure on the dollar, since fewer people will be scrambling into "safe haven" assets like the dollar and Treasury bonds (as they did back in August 2011 when Standard & Poor's cut our AAA credit rating).
And the Federal Reserve is preparing to do its part in a few weeks as it gets set to replace the expiring "Operation Twist" initiative (which had the central bank selling its short-term Treasury bond holdings and buying long-term bonds at a rate of $45 billion a month) with a new purchase program. The new program, which will be the fourth round of "quantitative easing" since the 2008 financial crisis, will likely see the Fed continue its $45 billion-a-month in Treasury bond purchases, but funded with newly created dollars.
Combined with the ongoing "QE3" program of mortgage purchases, the Fed will be injecting $85 billion a month in new dollars until the job market improves "substantially" in its view. Who knows how long that will take? Already, the Fed's actions have caused the monetary base -- a measure of the money supply -- to explode from $800 billion before the crisis to $2.7 trillion now.
If there is more of something floating around, it becomes less valuable, and the dollar is no different from any other commodity. If there is less demand for dollars from the Chinese, the U.S. dollar will become less valuable. That will help reduce the price gap between U.S. and Chinese goods for shoppers from Beijing to Shanghai.
What it all means
For workers and the middle class, this means a few more years of austerity with flat wages, higher inflation, less spending and more saving. We must also engineer a re-acceleration in labor productivity. We need workers to get more done during their hours on the clock via new machinery and upgraded equipment. Like I said, it won't be easy, and it will require a careful balancing act by the Fed to keep inflation from getting out of control.
But if we're going to close the competitiveness gap with China and India, we must do it via a combination of lower inflation-adjusted wages, increased productivity and more-desirable goods and services. That will eventually increase the demand for American workers, and in time, result in an increase in inflation-adjusted wages again. It will also increase opportunities for export-oriented small businesses.
Thankfully, you can use your retirement account to ease the pain.
A weaker dollar will be a boon to stocks (especially foreign issues), commodities and precious metals. All of these will move higher on a combination of better economic growth prospects (via exports) and a loss of the dollar's purchasing power. Either way, as the greenback weakens, investors should be looking for opportunities.
Examples include iShares Silver Trust (SLV), United States Oil (USO) and iShares FTSE China 25 Index (FXI) exchange-traded funds. For more nimble traders, I've been recommending shares of individual energy companies as well as a play on industrial metals to my clients including the PowerShares DB Base Metals (DBB) exchange-traded fund and Tesoro (TSO). Tesoro, a petroleum refiner and marketer, is up nearly 10% since I added it to my Edge Letter Sample Portfolio on Nov. 16.
At the time of publication, Anthony Mirhaydari did not own or control shares of any company or fund mentioned in this column in his personal portfolio. He has recommended PowerShares DB Base Metals and Tesoro to his money-management clients.
Be sure to check out Anthony's new money management service, Mirhaydari Capital Management, and his investment newsletter, the Edge. A free, two-week trial subscription to the newsletter has been extended to MSN Money readers. Click here to sign up. Mirhaydari can be contacted at anthony@edgeletter.com and followed on Twitter at @EdgeLetter. You can view his current stock picks here. Feel free to comment below.
