The title might look to some of the reader as provocative, and I have to admit that it is extreme on purpose. It is right that the dollar has appreciated against most of the leading currencies in the world in 30 to 54 percent during the last few months. For an example one Euro was equal to 1.6 USD few months ago and it is now traded for 1.3USD. One USD was equal to 1.03 Australian dollars few months ago and now is traded for 1.59 AUD.

But the fact that something that looks like an extreme scenario does not make it unreasonable. In economy there are cycles that keep repeating every time with different customs. A lack of balance that is being built gradually. Because of the slow speed of this process, people get accustomed to it, while they think that this situation makes sense. The truth is that this lack of balance was not always like that, but because of the slow trend we think that “it was always like that and that it makes sense”

Macro economic problems are like dirt. You can not just sweep it under the carpet, and hope nobody will notice… During the last few months the Americans are returning cash home from Australia, New Zeeland, Britain, Brazil and Turkey… The currency appreciated vs. the Euro in 26%, The Australian dollar in 54% and the British pound in 30%. Long term this does not make sense and will have to change. This article will elaborate the reasons why.

Why American trade deficit can not continue to grow for ever?

Until the 80′s America had surplus in its trade balance with most countries. From the beginning of the 80′s the trade balance changed and the US economy shifted from surplus to deficit. From the year 2000 when the hi-tech bubble burst, Federal banks tried to stimulate the economy and encourage American consumption artificially by lowering the interest rates and lending money from China, Europe and Japan to pay for the trade balance deficit. The result is that American debt is now over 11 trillion dollars – almost 100% of the GDP of the US. This is similar to countries like Argentina and Turkey, and much worse than most OECD countries. I claim that this situation is bound to change as part of Barack Obama’s reforms to the American economy.

Why is American trade deficit bad for the global economy?

This situation of lending money from Europe, China and Japan is like a situation where the Smith family from New York is lending money from the bank for 30 years in order to buy property, until their debt is more than their annual income. Eventually the smiths will have to pay back or the bank will decide to start foreclosure procedures. This is exactly what has to happen between the US and Europe, China & Japan. The Americans will have to pay back. There is only one way to do it – Stop lending money and starting to return money by reducing imports and increasing exports.

Why a week Dollar is a must to decrease American trade deficit?

For this to happen American exports needs to grow and imports to decline until the trade balance will be normal again and the debt will start decreasing.

Let’s look at an American software exporter that aims to sell his software in Europe, China and Japan. Let’s say that an Average software as now being sold for 1,000 USD (6,800 RMB). If the dollar / RMB exchange rate will depreciate to 4.00 the actual software price will still maintain 6,800 RMB price but in USD it will be 1,700 USD. This will generate for The American Company much higher revenues in USD, while their cost remains the same in the US. They will also be able to compete better with Chinese and European Software developers and thus contribute to increase in Exports.

On the other hand let’s look at a toy manufacturer from Guangzhou, China that now receives 10USD for average item he exports to America. Let’s say the cost is now 8USD which is 54 RMB. If the exchange rate will be reduced to 4. The revenue per item will drop to 40RMB, thus making it impossible to export to the US and the exporter will need to shift his focus to Europe, other markets in Asia and of course focus on Chinese consumers. Transferring toys to the US will not make sense any more. This will enable the American local toy producer to compete better in American local markets.

The final outcome of both would be that Chinese will import more products and services from US companies, while Chinese exporters will try to divert some of their exports to countries that their currency is stronger. The impact would be higher American exports, lower imports, lower debt. I claim that there is only one solution to the rising trade deficit which is a weak dollar.

This represents an average decline of the USD of 40% compared to most major currencies and some of the emerging market currencies as well. If you are considering investing in American stock or bond markets, you must take it into consideration. I estimate that the procedure would be gradual but in reality, Foreign exchange market can react very fast, thus enhancing the speed of this procedure

Disclosure:

I am an analyst in my blood. I always check other analysts my self before I act upon any recommendation. I strongly recommend you to do the same before you follow my recommendations. Especially when I try to predict currency exchange rates which is one of the biggest challenges in economy.