By Scott Sumner
There is a sort of zero sum aspect to exchange rates. Any change in exchange rates means one currency is weaker and one is stronger, relative to the other. But exchange rates tell us nothing about whether currencies are weaker or stronger in any useful absolute sense. Think about that fact when reading the following:
Expectations that the Federal Reserve is on course to start tightening policy has spurred fears of a return of last year’s emerging market turmoil, but Societe Generale (Euronext Paris: GLE-FR) tips a strong dollar as a bigger risk.
“A strong dollar tantrum could be a more worrying scenario than a Fed tightening tantrum,” Michala Marcussen, global head of economics at Societe Generale, said in a note dated Sunday.
The U.S. dollar index (New York Board of Trade (Futures): =USD) has climbed around 7 percent this year, with the Fed now nearly completing the tapering of its asset purchases, with markets widely expecting interest rate increases to begin sometime next year.
Some analysts are concerned this will spur a repeat of the “taper tantrum,” when concerns about the Fed’s move to begin tapering caused a brutal selloff in emerging market assets earlier this year and last year.
“Hope today is that a strong dollar will cap U.S. inflation, delay Fed tightening and boost exports to the U.S.,” Marcussen noted, but she believes for that to happen, the U.S. dollar would need to strengthen so much that it would signal much weaker growth in the rest of the world.
To delay Fed rate hikes, the euro (Unknown:EURBA=) would need to fall to $1.10, while the U.S. dollar would need to fetch around 120 yen (Exchange:JPYUSD=) and 6.50 yuan , she said. Early Tuesday, the euro was around $1.2690 and the dollar was fetching 109.40 yen and 6.1495 yuan.
“In such a scenario, [a strong] dollar would equate to further capital outflows, placing further pressure on already vulnerable economies,” she said. “A ‘dollar tantrum’ scenario could well prove more painful than a ‘Fed tightening tantrum,’ assuming the latter comes with better growth in the rest of the world.”
This is a messy and very confusing discussion, but it’s unfair to simply blame the reporter. We are all hamstrung by a lack of relevant real time data. Look at the last few paragraphs. This indirectly gets at the fact that a strong dollar due to monetary stimulus in other countries is bullish for the world economy, whereas a strong dollar due to tight money in the US is bearish for the world economy. Unfortunately, the dollar’s exchange rate by itself doesn’t tell us which one is occurring. Hence the discussion is muddled. We need data on whether the dollar is getting stronger in some sort of absolute sense, not relative to other currencies.
We can get some extra information by looking at other asset prices; TIPS spreads, stock prices, commodity prices, etc. But those are also affected by other factors. Thus if China shifts from heavy industry to services, it will reduce global commodity prices and also reduce US TIPS spreads. But it’s not necessarily contractionary for the US. It need not reflect slower expected NGDP growth in the US.
What we really need is a real time indicator of the stance of US monetary policy, a deep and liquid NGDP futures market subsidized by the US Treasury or Fed. It’s a scandal that we don’t have that market, and thus I am currently in discussion with some private individuals who are trying to set up such a market. I hope to be able to announce something soon. But these markets are incredibly cheap to set up, so economists really ought to be asking the US government why this market hasn’t already been created. The government could set up a much better market than I can.
Unfortunately, economists seem remarkably uninterested in real time data on market NGDP expectations. They seem happy to keep on discussing ambiguous indicators like “the dollar”, and then pointing out that dollar moves up and down could mean one thing or another, depending on other factors. So they put no pressure on the government to provide this sort of useful real time data on the most important cyclical indicator in the world—US NGDP growth expectations. We are flying blind.
PS. Does this have anything to do with “liberty,” the theme of this blog? Consider that unexpected sharp declines in NGDP growth expectations, such as 2008-09, lead to all sorts of mischievous government policies that make us less free.