Are measures of currency valuation worth it?

>> Prospects for the US dollar against major currencies

We say this because the Coalition for a Prosperous America (CPA), a bipartisan group representing US manufacturers and their employees, argues in its latest currency misalignment monitor that the US dollar is overvalued by nearly 16% and, on some measures, as much as 25% above its ‘fair value’.  

Ideas about ‘fair value’ for currencies have been around for decades, and, as we know, most currencies, not least the US dollar, have avoided trading in line with fair value over much of this period. Of course, ‘fair value’ is not a concept that suggests currencies should sit atop this fair value calculation and never move.

Instead, they are just a guide, perhaps best thought of as a piece of elastic that conditions the extent to which currencies can stretch themselves away from their fair value before snapping back. This snapback might occur naturally, or policymakers can try to force the move with intervention.

Right now, the CPA estimates that the US dollar is overvalued by 15.8% while most other currencies are undervalued, led by the yen (43.7%), the euro (23.4%) and the renminbi (21.8%). This calculation is based on an estimate of how much currencies would have to adjust simultaneously in order to bring about a current account balance within a five-year period. If other currencies were stable and all the adjustment had to occur through the US dollar, then the extent of the US dollar’s overvaluation would rise to a huge 25%.

Notably, there is no need for countries to hold their current accounts in balance any more than there’s a requirement that governments always balance their budgets. Now, if the current account deficit is particularly large, there might be pressure for currency adjustment but at around 3% of GDP right now, the US current account deficit is about half of what it was at its weakest point, in 2006, when it was around 6% of GDP – and that did not lead to an implosion in the greenback.

We might also note that the dominance of the US treasury market and the dollar means that the US can rely on adequate inflows of foreign savings to fund the deficit in a way that no other country can achieve. In other words, a 3% current account deficit-to-GDP ratio is less onerous to the US than it might be to another developed-country central bank and certainly less problematic than it might be for most developing countries.

One other argument we hear is that the FX market is so big at around USD7tr per day, with the vast bulk of this being trading in the US dollar, that it totally dwarfs the $800bn–plus annual current account deficit. It suggests that the scope for the tiny (current account) tail to wag the humongous (FX market) dog is practically non-existent. If there are so many flaws in these ‘fair value’ measures, particularly when it comes to the dollar, why mention them at all?

>> What will happen to the US dollar if Trump wins again?

Steve Barrow, Head of Standard Bank G10 Strategy, said they are relevant because of the US election in November as both parties will clearly court manufacturing firms, not least in key swing states such as Pennsylvania and Wisconsin. President Biden has just announced a raft of new tariffs on China, which is music to the ears of groups such as the CPA. His adversary for the presidency, Trump, is seemingly entertaining the idea of 60% tariffs on all Chinese imports (and 10% from all other countries). But Trump also seems likely to take up the cause of an excessively strong US dollar, as pointed out by the CPA.

Now, having sympathy for the idea that the US dollar is excessively overvalued is one thing, doing something about it is quite another. Trump was never shy of bemoaning US dollar strength in his first term, but did nothing directly about it. "Of course, tariffs were imposed and China was labelled a currency manipulator, but these things are a world away from active intervention to influence the currency, as we have seen recently in Japan. But even such intervention might prove ineffective when it comes to the dollar. So, should dollar bulls be scared at this point? Not really. But as the election debate heats up, so this issue might gain more airtime, and that could ultimately put the US dollar bulls on the backfoot", said Steve Barrow.