With the mainstream media bombarding us with fairytales about the imminent collapse of the U.S. financial system because of the budget impasse in Washington, I am asking you to step back, take a deep breath and consider all the good things about our country.
Today I am going to drill down into one of the primary reasons why I believe better days are ahead for the U.S.: A strong dollar.
|Taking a long-term view, the dollar has a lot going for it.|
I’m bullish on the dollar’s future because — despite the squabbling among our politicians — foreign investors love investing in the U.S. According to the IMF, 62 percent of the world’s currency reserves are in dollars, and the euro’s share has fallen to 24 percent from 29 percent four years ago. In fact, at the end of 2012, foreign investment in America exceeded U.S. investment abroad by $4.4 trillion, up from $4 trillion a year earlier.
A review of history — since ancient times — reveals six attributes required for a currency to have global dominance. Taking a long-term view, the dollar has a lot going for it in each of these areas. (In a related article, please see Money and Markets’ Facebook page for my take on the U.S. stock market and the golden age of investing.)
1. Growth in the domestic economy and GDP-per-capita resulting from productivity increases. Growth is the magic elixir that heals all economic problems. That’s why it’s the most important factor for a dominant international-trade and reserve currency. It was paramount to the British sterling’s success in the 19th century and the dollar’s superior position since then.
Over the past 10 years, the U.S. has led the developed world’s economies in productivity gains. An emphasis on entrepreneurial activity and superiority in developing new technologies provides promise that the U.S. will continue to be a world leader.
2. A large economy. Size has been a dominant factor going all the way back to the Roman Empire. With rapid productivity growth and relatively open immigration, the U.S. will probably continue to lead the world. Population is falling in Japan and will soon decline in other developed countries. And because of its one-child-per-family policy, China will struggle to continue its rapid economic progress.
3. Deep and broad financial markets. Money moves anywhere on the globe it can find the best risk-adjusted returns. Thus, to maintain an edge as a preferred place to invest requires not only a powerful and large economy, but also highly developed markets.
The U.S. Treasury market trumps all others in size (see chart, below) and is regarded as the world’s safest. About half of U.S. Treasuries are held by foreigners. In contrast, only 9.1 percent of Japan’s net government debt is owned by non-Japanese.
More importantly, the American stock market’s capitalization is four times that of China, Japan or the U.K., and is over three times the euro zone’s (see chart, below).
4. A free and open economy and financial markets. Foreign investors are willing to hold a country’s currency if they’re convinced they can invest it in financial or tangible assets with few restrictions. The U.S. is essentially open, which is a requirement for the Chinese and Japanese to continue to recycle their trade surpluses into Treasuries and other dollar-dominated investments.
Europe is less open because of recent controls imposed as a result of the euro-zone crisis. China’s policy of maintaining tight controls over its financial markets and currency severely handicaps the yuan’s viability as an international trading and reserve currency.
5. Lack of alternatives. A dominant global currency has no close competitors. But the risk is that larger countries grow complacent, leading to their downfall. That’s how the Dutch lost out to the British in the late 1700s and, in turn, the U.K. was over taken by the U.S. about a century ago.
Because of rigid governmental control over the Chinese economy and financial markets, the yuan will not be a rival to the dollar for a while. Export-dependent Japan does not want the yen to become a primary global currency because it’s currently focused on domestic policies designed to bring an end to its deeply imbedded deflationary problems. And the euro is eliminated because of Europe’s financial crisis, recession and austerity measures.
6. Credibility in value. Money runs from the threat of devaluation.
That’s what caused the Roman aureus, the Byzantine solidus and the Arabian dinar to lose their worldwide status. Looking at more recent times during World War I, Britain was forced to drop the gold standard because of immense wartime inflationary pressures, which vastly overpriced sterling. This action led to a mass exodus of money from the U.K., primarily to the U.S.
Although credibility in the dollar has been strained by its overall decline since 1985 (see chart, below), the world’s trust in the value of the dollar is still substantial.
The troubling U.S. current account deficit will continue to be an issue but will likely shrink as the country moves toward energy independence and regains a leadership role in precision manufacturing.
Moreover, competitive currency devaluations by other countries will ultimately reinforce the dollar’s status as the only safe-haven currency of any size in a persistently uncertain world.
I remain optimistic about the U.S. in the long run because of the dollar. It reflects America’s relative economic, political and financial leadership as well as the dollar’s status as the world’s primary reserve and trading currency.