Even during tough times many try to keep up with the Joneses. This classical benchmark says we are only doing well if we do as well as our neighbors.
For a country’s economic well-being, such comparisons are made every day in the foreign exchange market. The forex market is the largest market in the world, with more than $2 trillion in transactions each day.
Lately, neighborly comparisons in the forex market suggest the United States is not well off.
Fundamentally, the true economic value of anything is not its dollar value, but its exchange value. The exchange value of all items (commodities, services, etc) is not identical to their price. The exchange value represents the quantity of other items for which they can be traded.
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The value of one country’s currency relative to another is a direct measurement of relative economic conditions, or economic value. This assessment is made each day as traders, businesses, and investors, exchange one currency for another.
This week the relative economic value of the United States dropped precipitously. Further, the current declining trend is broad-based, with declines against many major currencies.
The Wall Street Journal reported this week that the dollar fell against all six components of a key U.S. dollar index — the euro, Japanese yen, British pound, Swedish krona, Swiss franc and Canadian dollar. Since the end of June, this index is off nearly 6 percent. Against developing countries like Brazil the dollar has fallen more than 20 percent.
Thus, current U.S. economic output of goods and services is worth less than similar goods and services in many other countries. In addition, the value of the dollar is falling against major commodities.
The dollar price of oil, silver, copper and other commodities also rose this week, with some reaching new highs for the year. Gold is up 7.5 percent since July, now trading at $1,000 per ounce.
These market actions all indicate higher inflation expectations for the United States. Current price indexes such as the CPI remain low, but such measures are lagging indicators of inflation.
A separate indicator of U.S. inflation expectations is the yield curve — the spread between the yield on short-term U.S. Treasury bills and long-term U.S. Treasury bonds. This spread is currently 2.5 percent, which is higher than last year but unchanged since early this year.
A wide yield spread indicates investors require more return for longer-dated bonds to compensate for higher expected inflation. Contrary to the actions in currency and commodity markets, the U.S. bond yield curve is not predicting high inflation.
The conflict between a rapidly depreciating currency and a less-than-steep yield curve can be partially explained by U.S. Federal Reserve policy. After the financial crisis last fall, the Fed began direct purchases of U.S. Treasury bonds. This artificial demand for notes and bonds is holding long-term interest rates down.
The falling value of the dollar is a direct assessment of current economic conditions in the United States. Without change, consumers and businesses will quickly see higher costs and slower growth.Policymakers would do well to keep their eye on the Joneses.
Peter R. Crabb is a professor of finance and economics at Northwest Nazarene University in Nampa. He earned his doctorate in international and financial economics from the University of Oregon.