Don’t Count Out the Dollar

There’s been a good amount of anxiety over the U.S. Dollar’s decline over the past few weeks.  While unsettling, much of recent dollar action has been determined by the general level of anxiety in the global markets — the dollar benefited from “flight to safety” concerns, spiking higher as the financial crisis peaked in the fall of 2008, and then stengthening again as global equity markets faltered in the first quarter of this year.  The chart below illustrates the past six months performance of equities (the S&P500 bar chart) versus the U.S. Dollar Index (line chart) — the plots are virtually mirror images:

U.S. Dollar Index (line) vs. S&P 500 (bar)

U.S. Dollar Index (line) vs. S&P 500 (bar)

The longer term direction of the U.S. dollar versus other major currencies may well be. “sideways.”   Some perspective here is useful.   Consider the following chart of the U.S. Dollar index going back to the beginning of 1975:

U.S. Dollar Index: January 1, 1975 to present

U.S. Dollar Index: January 1, 1975 to present

As happened after the precipitous fall of the dollar in the late 1980s, the recovery period required a multi-year basing process, where the dollar essentially traded in a limited range for roughly five years.  At a minimum, anecdotal evidence suggested that on a purchasing power parity basis alone, the dollar was oversold by the end of 2007.  Speculative excesses and leveraged speculative trades against the dollar eventually relaxed and were unwound by the financial crisis. 
The main argument for a further weakening of the dollar, our aggressive monetary stimulus, is indeed compelling, but only when viewed versus hard assets, and not against the currencies representing the weak developed economies around the globe.   Investors fearing dollar devaluation may find better solutions in U.S. equities tied to hard asset prices rather than foreign securities that traditionally benefited from a weaker dollar.

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