Friday, January 15, 2016

The strong dollar is crushing the world.

This article was written by Jack Rasmas on January 4th 2015. I blogged about it on the 29th of January last year.

I never post this much of some one's article, but I know most people won't click through. This guy is brilliant at explaining what is going on, and has been going on, for more than a year. The strong dollar is having very dire consequences right now. And none of that is going to get better until other currencies rise. Or ours falls. I would encourage EVERYONE to read the complete article which is quite a bit longer. It is a little dry, but it explains our economy right now. This is an extremely scary time. Especially if our dollar gets any stronger. Emphasis mine.

"What effect a deep and sustained oil price deflation will have on the global economy — which is already drifting toward stagnation and, simultaneously, rising financial instability — is hardly being discussed at all in the western business press. Instead, oil deflation is reported as a positive economic development, both for the advanced economies (AEs) and for emerging market economies (EMEs), as well as the global economy in general.

Economists, the business press, and governments in the advanced economies are all giving a ‘positive spin’ to falling oil prices, claiming it will mean lower costs to both businesses and consumers in the AEs. Lower oil prices mean lower gasoline prices and thus more for consumer households to spend elsewhere. Lower oil costs will stimulate business investment and spending, it is argued, and thus also boost economic growth. But this simplistic view may prove incorrect, not only for the AEs but for emerging market economies in particular and for the global economy in general. The combined negative effects of deep and sustained oil price deflation may well outweigh their positive effects.

There are at least three major potential impacts on global economic instability that will likely follow in the wake of global oil price deflation, some of which have already begun to appear:

First, a more rapid appreciation of the US dollar, and the corresponding relative decline in the currencies of a number of emerging market economies (EMEs) — in particular those dependent on commodity exports and especially those for whom oil exports make up a significant percent of total exports. There is a long, historical and documented relationship between falling oil prices and a rising US dollar. So global oil deflation means a rising US dollar.

A second destabilizing impact from falling oil prices will be to contribute toward general deflation in Europe and Japan. Economies there have already entered recession. Despite trillions of dollars of liquidity injections by their central banks in recent months, price levels have still fallen to zero or less. Oil deflation will add significantly to a general deflationary drift in both Europe and Japan. That in turn will likely lead to even more liquidity injections by their central banks, in the form of more quantitative easing (QE), further feeding stock market and bond asset bubbles.

Third, decline in financial assets tied to oil could increase the tendency toward global financial instability. Oil deflation may lead to widespread bankruptcies and defaults for various non-financial companies, which will in turn precipitate financial instability events in banks tied to those companies. The collapse of financial assets associated with oil could also have a further ‘chain effect’ on other forms of financial assets, thus spreading the financial instability to other credit markets.

The positive impacts of falling oil prices on economies, including the USA, are generally over-rated. Oil price declines may not have as much positive impact on consumer spending and business investment that many in the AEs now assume. The total net effect on the global economy will therefore likely prove more negative than positive.

Oil Deflation’s Potential Impact on EMEs

The continued collapse of world oil prices since June has already been having a devastating effect on emerging market economies, especially those dependent on commodity exports — like Brazil, Chile, Argentina and South Africa, and even Australia and a number of economies in southeast Asia. Oil deflation has had an even more severe impact on those EMEs highly dependent on oil exports as a large percentage of their commodities mix — like Venezuela, Russia, Nigeria.

The initial transmission mechanism by which global oil deflation negatively impacts EMEs is falling currency exchange rates. Oil price deflation is generally associated with a corresponding rise in value of the US dollar relative to other currencies. A rising dollar in turn means falling currency values for other countries.

Since the collapse of global oil prices began in earnest last June, the Russian Ruble has fallen approximately 38 percent.  The Venezuelan currency, the Bolivar, by around 45 percent. Nigeria’s currency, the Naira, has declined 12 percent just since mid-October. Even the currency of developed oil exporting countries, like Norway’s Krone, has fallen 17 percent.  After having remained stable for several years, the US dollar clearly began to rise last June, as global oil prices commenced their freefall that same month. So falling oil prices drive the dollar up and in turn depress EME currencies, and especially depress the currency of oil exporting economies. And the more dependent the economy is on oil exports, the greater the EME currency decline.

I don't even know how saggy all the currencies are right now. This article was written a year ago, and things have not really recovered since then. I know Canada and Australia are down in the .70ish range. Which is not good honestly.


  1. I don't think low oil is all that bad. The cheap gas and strong dollar means that our costs for parts and transportation are being driven lower and these are our two biggest expenditures. In that sense, it is a boom for businesses. Consumer discretionary spending maybe focusing on value right now buy I don't think that the price for finished goods has seen much of a haircut. I think the individuals that are most impacted by deflation is those who are in debt because the payments are more expensive. You could probably do well right now by betting on debt heavy companies to under perform while betting on cash heavy companies to outperform. DF

  2. A low energy price has always been what built America. In a different world I would agree with you. And in a while I believe that will be true again, it isn't true right now. While purchaser prices going down I'm sure feels good to you now, the part that always bothers me is that economists never explain why "payments become more expensive" in deflation.

    Generally it's because people are making less money from their companies. Have lost money in the market, or are taking a wage hit. During the first two years of the Great Recession, tons of companies in Silicon Valley were on 10% pay reduction. Including the snarkolepsy household. You can already see this happening in the oil sector where they are freezing wages from CEO's to janitors. All of these things override the benefit of lower gas prices and cause people to hoard money. If you don't see a raise in your future you keep a tight rein on spending. Very few companies or even individuals escape this. EVERYONE is affected in deflation because there are no wage increases. Prices for things can only go so low. They generally are not going to sell things at a loss. Even if it sits on their shelves forever. And people start worrying about their jobs because the companies are not making as much money. This is why people don't really spend in deflation. It's wasn't the boon in the Great Recession. And really - if it was that good - why doesn't the Fed target deflation rather than 2% inflation? Deflation has a philological element that unless you've been under that strain you can't recognize the reason people are behaving in certain ways.. Deflation flat our feels like you are swimming in quicksand. You can never get ahead. It feels horrible all the time.

    Now if we still have low oil prices after most of the companies have died - it might help rebuild us. No one planned for sustained low oils prices. That is going to leave a mark.