True or False: As the U.S. trade deficit decreases, the value of the U.S. dollar increases?
According to mainstream economic wisdom, that statement is true as steel. Case in point: On June 27, the Group of Twenty (G-20) summit disclosed part one of their broad strategy to ensure global economic recovery. Coined the "Deficit Reducing Pledge," the objective is to slash deficits of the world's leading economies in half by 2013. For the United States in particular, the long-term goal is to shrink the trade gap to 3% of GDP from its current level of 10%-plus.
In the words of one news source: This policy is "one of the most aggressive goals to reduce deficits" ever, especially as it comes from the Great Oz of finance, the G-20. When then the dollar turned up in trading the following day (June 28), the usual suspects had their cause --
- "Dollar Rises After G-20 Pledges To Cut Deficits" (MarketWatch)
- "Dollar Nudges Higher After G-20 Summit" (AP)
- "The dollar rose against the euro after world leaders pledged to significantly reduce the deficit. As investors worry that drastic deficit cuts could hurt the fragile state of the global economy, the safe have dollar is increasingly attractive." (CNN Money)
That all sounds perfectly logical, until you start to pay attention to the man behind the curtain. When the screen falls, one thing becomes shockingly clear: An inverse correlation between the deficit and the dollar does not exist.
I repeat: The deficit and the dollar do NOT consistently move in opposite directions. On this, the December 2004 Elliott Wave Financial Forecast presented this ground-breaking chart of the past three decades of the US Trade Weighted Dollar versus the Current Account Deficit/Surplus (as a percentage of GDP).
Here are few of the startling results:
- From October 1980 to February 1985, as the deficit emerged as the largest in well over a decade, the dollar surged 50%.
- From April 1995 to December 2000, the deficit took another huge leap and the dollar rallied 34%.
And, these later observations: From December 31, 2004 to November 2005, the deficit widened to the largest on record while the greenback enjoyed a steady, 15% uptrend.
2007: U.S. trade deficit narrowed for the first time in six years, all the while, the dollar sunk to new record lows against the euro. Also, a record deficit in 2008 coexisted with a 6% rally in the U.S. dollar index.
The list goes on, suffice to say: Fundamental analysis of the world's leading currencies is a costly detour on the greenback road to opportunity.