Registered Rep. spoke with Boris Schlossberg about the dollar's recent decline.
Registered Rep.: What are the major reasons behind the weakness in the U.S. dollar?
Boris Schlossberg: The biggest reason for the weakness in the U.S. dollar is the fear in the marketplace that the U.S. economy is slowly headed into a recession. The other big reason is the fear that the bad debts that were accumulated in the sub-prime mortgage fiasco are essentially going to be monetized — meaning the Fed will print more dollars to extinguish these bad debts. The other big dynamic is that for the first time since last century, we have a viable alternative to the dollar as a reserve currency: the euro.
RR: What are the risks of continued weakness in the dollar?
BS: Ironically enough, for the last three or four years, there has been an inverse correlation between the U.S. dollar and the U.S. stock market. The reason why is twofold: Virtually every Dow Jones Industrial 30 corporation is a major multinational that, in many cases, makes more money abroad than it does in the U.S. market. Therefore, a lower dollar is incredibly favorable for them because they become low-cost producers. The second reason has to do with the carry trade. The carry trade is the practice of buying high-yielding currencies, and financing them with low-yielding currencies: The quintessential example is buying long euros, which yield 4 percent, against Japanese yen, which only yield 0.5 percent. When stock markets rise, the carry trade thrives because there is a huge appetite for risk, and the euro/yen goes up. This pulls the euro up with it, causing the dollar to decline. That kind of tap dance has been going on very actively over the last several years.
RR: Are there any negatives associated with long-term dollar weakness?
BS: Dollar bears fear that the decline will get out of control due to fears that the currency is worth nothing. A sudden decline — like 2 to 3 percent in a day — would definitely be very negative for the economy: It hurts our ability to transact with the rest of the world, which is crucial, because we still run very large trade deficits. What would cause that to happen would be an event that would make the market lose all faith in the credit of the U.S., a failure of a large bank — something that could cause a financial shock to the system.