It is one of the seeming incongruities of our time: U.S. stock markets oscillate at 10-year lows; the federal budget deficit will exceed $1 trillion for at least the next two years; and Congress will likely have to raise the national debt ceiling about $13 trillion -- all negative developments for the dollar.
And what's the world clamoring for? More dollars. The dollar was mixed Wednesday at mid-day against the world's other major currencies -- strengthening slightly against the Swiss franc, but falling against the euro, British pound, and yen -- but that doesn't blot out the dollar's bullish pattern during the United States' worst financial condition in decades.
A paradox? Not really
Theater of the absurd? Hardly, say economists and experienced currency traders.
First, despite a decade of policy errors by the United States, the dollar remains a safe haven -- the world's safest investment after gold (and some argue, it's safer than gold). And in a world permeated by uncertainty, risk, and fear, amassing safe assets is the order of the day. (Let's hope it's not the order of the next decade.)
Second, the global recession and accompanying, unfortunate asset destruction are also increasing demand for dollars by international players. In a dollar-denominated system, during a recession your revenue in dollars decreases, and asset prices fall. But your borrowing costs do not fall. If you still plan to service that debt, and most institutions do, you'll need more dollars, which creates a shortage dollars, boosting the dollar's value.
Analysis: Ideally, investors want the dollar to rise on the U.S. economy's positives, not other nations' (or the financial system's) problems, but in this market you take what you can get: the dollar's strength protects, to a certain degree, the value of U.S. investments, and makes it less likely financial institutions will start pulling money out of the United States, due to its economic woes and bearish stock market. The dollar's strength also has lowered short-term interest rates for the U.S. government - - enabling the federal government to finance is huge deficit at interest rates lower than would be the case in normal market conditions: that represents a huge interest expense savings for the U.S. taxpayer.
Further, the United States remains a very fortunate country, currency-speaking. No other nation in the world could run a record budget deficit, have its economy fall into a recession, and see its currency hold its own against the world's other major currencies. Morevoer, after the U.S. economy's recovery is firmly in place, that's all the more reason for President Obama and Congress to cut the U.S. budget deficit and begin paying-down the national debt: the low-interest-rate period produced by the huge flight-to-safety by institutional investors won't last forever. Hence, the smaller the U.S. budget deficit is, the lower the U.S.'s interest costs will be, moving forward.
Take the first steps to building your portfolio.View Course »