The strongest factors that we’ve found that explain movement of the US dollar are the Balance of Payments and Net Government Saving. Combined in a simple linear model, they have an R^2 of better than 0.8 — meaning that 80% of the US dollar’s action is explained by trade, capital flows & the deficit.
This makes sense, of course.
In the decade prior, the the Balance of Payments have had increased as a percentage of money supply to well over 3%:
The recession has rapidly forced the re-balancing of global trade, and this measure has snapped back to its 1998 levels. This has two critical drivers: a) the re-emergence of the US export economy through the increasingly competitive prices from the weakened USD and b) the collapse of consumer imports (down about a trillion dollars (SAAR) from peak to trough.
Trade has come roaring back, but the fuel of the recovery is clearly exports.
This looks good for the dollar.
As the same time, vertical money supply growth has clearly put a substantial pressure on the US dollar:
With tax revenue roaring back, government spending -7.9% q/q, and Obama’s projected cuts ($4T over 12Y, or -8.8% pa), Net Government Saving is likely to be higher this time next year.
Furthermore, a continued collapse in government spending is also likely to slow or stop growth unless private credit growth or exports can pick up the slack — which I doubt they can fully do. This would reverse speculative capital flows, and further strengthen the dollar.
As an aside, the size of the Federal Reserve’s balance sheet is only the 4th most statistically significant factor in pricing the US dollar after Net Government Saving, Balance of Payments and Interest Rates. Of course, there are some reinforcing factors there (large balance sheets drive down interest rates, and low interest rates promote capital outflows), but it is clearly not in the driver’s seat.
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