US Dollar At 20-Year High, Pound Sterling At 40-Year Low

FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
October 4, 2022

IN THIS ISSUE:

1. Commerce Department Confirms 2Q GDP Was Down 0.6%

2. US Dollar Surges Higher, British Pound At 4-Decade Low

3. Advantages of a Strong Dollar

4. Disadvantages of a Strong Dollar

5. Britain On The Edge of Recession, Currency At 40-Year Low

Overview: US Dollar Surging, British Pound Collapsing

The US dollar has soared to new record highs against many currencies this year. Meanwhile, the British pound has collapsed to a 40-year low against a basket of currencies and a record low against the US dollar. Both are interesting and significant developments, as I will discuss below.

But before we get to that discussion, let’s take a quick look at the latest and final Commerce Department report on 2Q GDP. In its final report on 2Q GDP, the Commerce Department confirmed that GDP growth was negative in the 2Q, but again, not by much. Here are the highlights.

Commerce Department Confirms 2Q GDP Was Down 0.6%

Last Thursday, the Commerce Department released its third and final estimate of 2Q GDP growth. The latest report was unchanged from its last estimate, which showed GDP declining 0.6% (annual rate). That followed a decline of 1.6% in the 1Q.

This raises the question of whether the US economy is in a recession now. As I have discussed often this year, the typical definition of a recession is two or more consecutive quarters of negative GDP growth, which we’ve just seen.

However, the labor market remains very strong this time around which raises questions about whether we’re in a recession or not. The National Bureau of Economic Research (NBER), which is the official arbiter of when recessions begin and end, still has not declared we’re in a recession.

Many forecasters believe we are already in a recession, and most others believe if we’re not in a recession now, we will be before the end of this year, and I would put myself in the latter camp.

So, we’ll have to wait and see what the NBER says just ahead.

Now let’s move on to our discussion of the super strong US dollar and the collapsing British pound.

US Dollar Surges Higher, British Pound At 4-Decade Low

You have to go all the way back to the early 1980s to find the all-time record high in the US dollar, but rarely has it been higher than it is today. The US dollar is now at a 20-year high against a basket of foreign currencies, as you can see in the chart below. Meanwhile, the British pound sterling has sunk to a nearly 40-year low and is at a new record low against the US dollar.

Chart showing the U.S. dollar index rising dramatically

Today we’ll look at why these exaggerated trends are occurring and what they mean for the respective economies and investors in general. But first a few basics.

A strong US dollar has several advantages and disadvantages. It benefits some but negatively impacts others. The dollar is considered strong when it rises in value against other currencies in the foreign exchange market. A strengthening US dollar means it can buy more of a foreign currency than before. For example, a strong dollar benefits Americans traveling overseas but puts foreign tourists visiting the US at a disadvantage.

Advantages of a Strong Dollar

Traveling Abroad Is Cheaper. Americans holding US dollars can see those dollars go further abroad, affording them a greater degree of buying power overseas. Because local prices in foreign countries are not influenced greatly by changes in the US. economy, a strong dollar can buy more goods when converted to the local currency. Expatriates, or US citizens living and working overseas, will also see their cost-of-living decrease if they still own dollars or receive dollars as income.

Imports Are Cheaper. Goods produced abroad and imported to the United States will be cheaper if the manufacturer's currency falls in value compared to the dollar. Luxury cars from Europe, such as Audi, Mercedes, BMW, Porsche and Ferrari, would all fall in dollar price. If a European luxury car costs €70,000 with an exchange rate of 1.35 dollars per euro, it will cost $94,500. The same car selling for the same amount of euros would cost $78,400 if the exchange rate falls to 1.12 dollars per euro.

If the dollar continues to strengthen, the price of imports will continue to fall. Most other imports will also fall in price, leaving more disposable income in the pockets of American consumers. US companies that import raw materials from abroad will have a lower total cost of production and enjoy larger profit margins as a result.

The status of the dollar as the world’s ”reserve currency” is bolstered with a strong dollar. While some countries, including Russia, Iran, and China, have questioned the status of the US dollar as the de-facto world reserve currency, a strong dollar helps keep its demand as a reserve currency high.

Disadvantages of a Strong Dollar

Tourism to the US Is More Expensive. Visitors from abroad will find the prices of goods and services in America more expensive with a stronger dollar. Business travelers and foreigners living in the US but holding on to foreign-denominated bank accounts, or who are paid incomes in their home currency, will be hurt and their cost-of-living will increase.

Exporters Suffer. Just as imports become cheaper at home, domestically produced goods become relatively more expensive abroad. An American-made car that costs $30,000 would cost €22,222 in Europe, with an exchange rate of 1.35 dollars per euro; however, it increases to €26,786 when the dollar strengthens to 1.12 per euro. Some have argued that expensive exports can cost American jobs.

US Companies Conducting Business Abroad Are Hurt. Companies based in the United States that conduct a large portion of their business around the globe will suffer as the income they earn from foreign sales will decrease in value on their balance sheets. Investors in such companies are also likely to see a negative impact.

McDonald's Corp. (MCD) and Philip Morris International Inc. (PM) are well-known examples of US companies with a large percentage of sales occurring overseas. While some of these companies use derivatives to hedge their currency exposures, not all do, and those that do hedge may only do so in part.

Emerging Market Economies Are Negatively Impacted. Foreign governments that require US dollar reserves will end up paying relatively more to obtain those dollars. This is especially important in emerging market economies.

Special Considerations. Economic theory holds that currency fluctuations will eventually revert to a mean, since cheap foreign goods should increase the demand for them, raising their prices. At the same time, expensive domestic exports will eventually fall in price as demand for those items declines worldwide until, ultimately, some equilibrium exchange level is found.

Britain On The Edge of Recession, Currency Falls To 40-Year Low

Not unlike the US, the British economy is teetering on the edge of recession. Most UK economists believe the economy will post slightly negative growth in the 3Q for the second consecutive quarter – a widely accepted definition of a recession.

The UK is suffering from soaring energy prices, inflation of 10% and an increasingly struggling economy. Meanwhile, its currency has plunged to a 40-year low against a basket of currencies and a record low against the US dollar as investors fear matters will only get worse just ahead.

Chart showing the british pound hitting a low in September

Britain’s new Prime Minister, Liz Truss, says she will lower taxes to boost the economy, but the reaction by the media has been mostly negative as her plans would significantly boost the country’s budget deficit. This is another reason why the pound plunged to a 40-year low.

On Friday, September 23 the Truss administration announced its sweeping plans to stimulate the economy. These changes included slashing the top marginal income tax rate from 45% to 40%. For an individual earning 150,000 pounds a year, this would mean an annual savings of apprx. 10,000 pounds (US$10,861).

On paper, this suggests Brits will have more money for discretionary spending, which should be good for the economy. However, the Truss administration also announced it will maintain current spending levels, meaning the government will have to borrow all the money to pay for the tax cuts.

This didn’t sit well with British and international investors in the pound and the pound fell to a 40-year low against several other currencies and record low against the US dollar. This serves to worsen the inflation spike in the UK which now stands at roughly 10% over the last 12 months.

The bottom line is the pound has crashed to new record lows against the US dollar this year, as you can see in the chart above. At this point, I wouldn’t advise investors to chase this trend as the big money has probably already been made, and risks of a reversal are high now.

For that reason, I’m not ready to recommend going long the British pound/short the US dollar. The pound could remain weak for a long time as the Brits have no good options for solving their economic and financial problems.

In closing, let me say our hearts and prayers go out to all the people in the eastern US and Puerto Rico and elsewhere who had their lives and property upended by Hurricane Ian. The photos from Florida and elsewhere are just horrendous! Hopefully, these people will be able to rebuild, but it will take years for the millions who lost everything to do so. We wish them the best.

Best personal regards,

Gary D. Halbert

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