By Ivan Illán
Amongst political and business leadership, there’s a popular bias that domestic currency depreciation and/or devaluation is negative for a nation’s economy. Instead, downward currency movements present a positive GDP benefit due to relatively favourable goods pricing offered to global consumers. Such a currency event will frequently act as a support to challenged economies during recessionary or transitionary periods.
One of my 2017 forecasts1 – dollar depreciation – is already being realised. The US dollar (USD) has been falling in relative value to other major currencies from its recent highs, but not because of an overnight shift in any fundamental factor. Instead, it’s due to President Trump merely commenting on his hope for a softer, weakened USD. On the day of this brief mention, the dollar fell more than 1%.2 Overall, the USD is down 3.3% from recent highs set late last year. However, a knee-jerk market reaction is unwarranted, as Trump’s comments are actually a fair desire. USD strength has had negative earnings implications to US corporations. Nonetheless, it’s simply amazing how a simple comment can elicit such swift market response on something that’s not even news.adjusted, trade weighted basis, compared to the Euro, Canadian dollar, Yen, Pound, and Swiss franc) is up more than 22% (see chart below). This has been a direct contributor to weakening US corporate foreign sales, as exported goods and services have had their prices skyrocket to importers over the past two years. A strong USD has been blamed as one of the more serious factors weighing down on US corporate earnings, as sales through foreign business units have suffered. For S&P 500 index companies, foreign sales are down to levels not seen since 2006.3 Though USD strength is a culprit, corporate tax reform addressing domestic and foreign earnings would be a far more valuable allocation of President Trump’s time, which would drive greater US corporate net earnings. That being said, all currency valuations are relative, and this is where the opportunity lies for all businesses anywhere to improve COGS and other expenditures. If USD strength has been harmful to US corporate earnings, then the inverse would be a welcome respite.
For reasons not entirely clear, discussions of any nation’s currency devaluation and/or depreciation on the nightly news are delivered with an ominous tone. But in fact, these seemingly negative currency fluctuations will more often yield beneficial domestic economic results. Whether its currency depreciation (for those which follow free-market exchange rates) or currency devaluation (for others that have fixed exchange rates controlled by a central bank), both provide the necessary fuel to allow sovereign nations a pathway out of a challenging economic environment.
Recently, the British Pound (GBP) is an example of how currency depreciation can be beneficial. Not only has a depreciated GBP been enjoyed by global consumers who are searching for the most favourable pricing on goods and services, but more importantly it has provided a nice support to the British economy by forcing domestic goods consumption over imports. Brexit’s full economic impact is still uncertain, but for now such uncertainty – and the resulting manifested GBP depreciation – provides market opportunity to both domestic goods producers and foreign consumers equally.
The USD/GBP exchange rate plummeted nearly 20%, from a pre-Brexit value of 1.4874 to a post-Brexit low of 1.2046 (USD/GBP) six months later, and has recovered lately against a weakening USD. The magnitude of GBP’s current depreciation has not been seen since 1984, but neither has the accompanying opportunity to stimulate global demand for British exports. To make the situation even more advantageous, much has changed since the last GBP collapse three decades ago. The most significant difference is that today a global retail or business customer can easily take advantage of a cost differential due to currency movements, as matter of technology. As an example, the on-line shopping portals for high-end retailers, like Harrods and Harvey Nichols, offer global consumers luxury product discounts that are hard to match elsewhere. Recent news on tepid October 2016 UK retail sales also had highlighted how UK leisure and luxury stocks4 have seen a nice valuation uptick. Apparently, global consumers from around the world are converging on London to pick up great deals that their homeland cannot provide. The extent of the discounts is impressive. Since January 2016, the US Dollar and Euro are stronger against the Pound by 19% and 17% respectively, while the Japanese Yen (JPY) to GBP is stronger by more than 25%.5
President Trump’s main currency rhetoric has been reserved for China as a currency manipulator. Most economists, myself included, understand that China’s Renminbi (CNY) is actively managed to a persistently devalued position relative to the USD. A Trump administration could certainly introduce tax policies on imported Chinese goods that would leave many US consumers paying much, much more for similar household goods, but for only as long as less expensive import substitutes would need to be supplied. Such brief trade disruption would not upset most Americans who shop at large discount retailers, but it would place the Chinese government on red alert (pun intended). As monetary retribution (not to mention the potential military avenues), China – the second largest foreign holder of US treasury securities6 – may find it most pleasing to dump their more than $1 trillion in treasury holdings on the open market. Such action would send the value of US treasuries plummeting and bond yields spiking much higher. However, this monetary attack could be effectively managed by the US Federal Reserve’s FOMC. Moreover, US exports to China about 7% of total exports, compared to 19% of US exports to Canada and 16% to Mexico – a combined 35% of US exports.7 It would not surprise me to find a Trump trade policy that starts sounding very sweet on Mexico and more punitive on China.
Meanwhile, the Mexican Peso (MXN) has fallen dramatically post-Trump victory. From November 8, 2016 through January 6, 2017, the peso fell more than 15% relative to the USD. The drivers for this movement have been clear. Fears abound, as Trump remains tough on border security/wall building, tariff impositions, and a wholesale review of the so-called “worst deal ever” – NAFTA. These three talking points have weighed heavily on the peso’s current value and future outlook. To add to these US-centric political pressures, a recent move by the Mexican government to cut gasoline subsidies is sure to contribute to rising inflation, which would further hurt their waning domestic consumption and increasing the possibility of recession in Mexico this year. With all these headwinds, it’s no wonder that the Mexican peso has been treated like a piñata at a kid’s birthday party. But, there’s a bright side.
The biggest positive for the peso’s future is that nearly 40% of the imported goods value from Mexico to the US is actually “Made in USA.”.8 This means that potential US tariffs imposed on imported Mexican goods would have the effect of directly impairing the earnings of the very US companies that Trump has vowed to protect. In addition, Mexico is a consumer nation, and it’s in the US’s best interest to keep our neighbour to the south in a healthy economic state. Mexico buys more from the US than Brazil, Russia, India, and China – combined. A more severely depreciated MXN would only serve to backfire on US interests, making US goods too expensive, and ultimately hurting US corporate revenues and earnings through falling exports.
Though the year ahead will undoubtedly be a volatile one for the MXN/USD exchange rate, it will most likely bottom out around 23, as Trump administration rhetoric heats up later this year. By year-end, it would be realistic to see the peso strengthen to levels seen prior to the November 2016 election, in the 18.25 to 19.75 range. Such a recovery would be seen as positive, by both domestic Mexican business consumers and the many US exporting companies who are so reliant on their orders. Such a symbiotic relationship may also yield another US benefit in that its southern neighbour would also become the market buyer in the event of China making good on its US treasuries liquidation threat. Mexico’s weakened peso also provides a nice substitute to the imported Chinese goods market.
Local currency depreciation is showcasing London as the international shopping mall for the best deals on today’s high-end merchandise. Conversely, China’s proactive CNY devaluation seems to be on a collision course with karma via Trump. Technology allows for consumers to access currency distortions in the form of buying discounts with a speed and simplicity never before experienced in our global economy. The economic support provided through a depreciated currency is due to the international consumer’s ability to focus their spending in those currencies, as with GBP for now. The “Big Brexit Sale” might just be the impetus to inspire other Eurozone nations to abandon their single monetary unit, the Euro. Though Britain never took on the Euro currency, its decision to leave the European Union has afforded it the depreciation benefits that will protect its economy from collapse. Countries like Italy, Spain, and Ireland would be very pleased to have the flexibility of their own currencies9 right now, instead of having to deal with out-of-touch, non-elected officials in Brussels. Global consumers and producers would certainly celebrate the chance to keep the good deals going from one nation to another.
About the Author
Ivan Illán is an economist and author of How to Hire (or Fire) Your Financial Advisor. Mr. Illán is a Forbes contributor, a Financial Times Top Financial Adviser, and a CFA Society Los Angeles Wealth Management League Founding Member.
1.The full 2017 capital markets forecast, can be found at: https://www.equities.com/news/politics-central-bankers-are-2017-s-key-market-themes
2.Based on the WSJ Dollar Index on Tuesday, January 17, 2017
3.Reported in the 2015 S&P 500 Foreign Sales Report; Standard & Poor’s
4.McClean, Paul, “UK retailers enjoy average October sales”; October 28, 2016, Financial Times, © 2017 The Financial Times Ltd. Full article found at: https://www.ft.com/content/9e091d62-9d03-11e6-a6e4-8b8e77dd083a
5.All currency data sourced from Bloomberg.com and WSJ.com subscription-level quotes
6.Department of the Treasury/Federal Reserve Board, January 18, 2017; Major Foreign Holders of Treasury Securities Report can be found at: http://ticdata.treasury.gov/Publish/mfh.txt
7.Data found at: http://www.worldsrichestcountries.com
8.Gutiérrez, Geronimo, “Mexico’s Growth Has Helped the U.S.”, November 24, 2013, © 2017 The New York Times Company; Full article found at: http://www.nytimes.com/roomfordebate/2013/11/24/what-weve-learned-from-nafta/mexicos-growth-has-helped-the-us
9. Smith, Reiss, “What is Italexit? Will Italy be next to leave the EU?”; September 23, 2016, © 2017 Express Newpapers; Full article found at: http://www.express.co.uk/news/politics/713818/italexit-will-italy-leave-eu-european-union-referendum-brexit-exit