I grew up in Rome, Italy in the late 1950s. My parents had an apartment on one of the Seven Hills of Rome. We lived one mile from the Circus Maximus, with its well-known oval shape, and two miles from the Colosseum.
Living so close to the famous tourist attractions I was able to see tourists coming from a wide range of countries. I was fascinated by people coming from north of the Alps: Germany, Austria, Switzerland, and Belgium, among others.
What impressed me about these people was they had much larger cars than those used in Italy. Furthermore, the government, to attract them to visit the country, gave them at the border a special coupon so they could buy gasoline at a much-reduced price. There was not an energy crisis. Prices were set by misguided government policies. Like in the 1970s in the US. One more thing these people had in common – they were all living in a country with a much stronger currency than the Italian Lira.
So, the idea of wealth, low prices, and large cars has always been with me and has always been associated with people living in a strong currency country. This is the main reason I shiver when I hear we should have a weak US Dollar. It would be easy to do it – debase the country as Brazil, Venezuela, Russia,……
Let me move forward about 15 years – the 1970s. I was associated at that time with a large company. The US Dollar was weak during that decade. Interest rates soared from close to 3% to about 20%. Inflation punished consumers and investors by rocketing to 16%. The US experienced a sharp recession about every 3 years. They were unpleasant times, to say the least.
It was not a coincidence the dollar collapsed during that decade. People in the auto industry were rejoicing because – so went the misguided logic – a weak dollar would make foreign cars more expensive and benefit the US auto industry.
They had it upside down. What happened was exactly the opposite. In 1950, only 21,287 units were imported. By 1977, imports eclipsed the 2 million-unit, due in large measure to improved Japanese and German quality.
The forecasters had it wrong. We bought foreign cars because they offered value. We could afford them, well-built, and using less gas. Japan and Germany could make better products than we could. To buy their cars, we had to sell Dollars and buy Yens or D-Marks. The outcome was a weak dollar and stronger Yen and D-Mark.
The important point is the Germans and Japanese manufacturers were successful because they had products we needed and they were producing them efficiently and cheaper than our manufacturers.
One more thought. A weak currency penalizes the weak currency country because it makes inaccessible all the imports needed to become more efficient due to cost increases due to the weakening currency. A friend once told me they could not buy an important German machine they needed to improve the quality of their products because a weakening Dollar made it eventually too expensive.
In more general terms, the Dollar was weaker because the productivity differential was in favor of Japan and Germany. Of course, there are other variables affecting a currency. Last, but not least, are the local government policies to attract or discourage capital inflows in that country.
The Dollar is strong because we have many industries highly competitive in the global markets. They deliver products the world needs. The world must sell their currency and buy dollars to buy our products and technology. The time government policies reduce innovation and the creation of globally competitive industries, the Dollar will become fundamentally weak. But not until then.
Often some experts suggest interest rates are a major driver of a currency. If this were the case, countries like Brazil, with some of the highest interest rates in the world, should have one of the strongest currencies – in the 1970s and now. And this is clearly not the case. The above chart shows the persistent strengthening of the Dollar against the Brazilian currency. Hedging models using only interest rates could be painfully wrong.
My point is the two major forces acting on currencies are productivity differentials (or inflation differentials) between two countries and government policies geared to improve the productivity of that country.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.