Stronger Dollar = Lower Growth

U.S. Dollar Index 2008 – 2015

What is remarkable about the ECB’s program to come, however, and that of other nations within the European Union which issue their own currency, is the extent to which yields have fallen – or been set – in order to regain a competitive currency edge. First the Swiss, then Sweden, then Denmark. Russia of course, was devaluing daily because of oil and geopolitical tensions.

Promoting almost all of these devaluations were policy rates that went negative – that’s right, short term money market rates that would cost banks and ultimately small savers to lend money, as opposed to good old fashioned positive rates that at least offered something in return. The universe of negative yielding notes and bonds in Euroland now total almost $2 trillion. Not even “thin gruel” is being offered to our modern-day Oliver Twist investors. You have to pay to come to the dinner table and then sit there staring at an empty plate.

The possibility of negative interest rates was rarely if ever contemplated in academia prior to 2014. No textbook or central bank research paper even mentioned it, although fees for safe haven “storage” have long been in existence at Swiss banks. Ben Bernanke in his famous 2002 paper titled “Deflation: making sure 'IT' doesn’t happen here”, mentions helicopters dropping money from the sky, but nowhere was there a hint of negative yields once a central bank reached the zero bound. It was as inconceivable as the “Big Bang” with its black holes that followed billions of years later; the rules of physics or in this case the rules of money didn’t apply; it was impossible to imagine.

But here we are. Negative 25 to 35 basis point money market rates in Germany with minus signs all the way out to six year maturities, reflecting the expectation that negative policy rates are likely in store for at least 3 to 4 years in the future. Sweden has gone the furthest with negative 75 basis points but Switzerland and Denmark are not far behind. Outside the EU, Japan is on a mission of once swift and now gradual devaluation of the Yen via QE – their interest rates having been near zero for years. Even China is lowering its rates seemingly to weaken its Renminbi relative to the dollar and is having some success in doing so.

All of this may seem positive for future global growth and in some cases it may be – lower yields make sovereign and corporate debt burdens more tolerable and their exports more competitive. But common sense would argue that the global economy cannot devalue against itself. Either the strong dollar weakens the world’s current growth locomotive (the U.S.) or else their near in unison devaluation effort fails to lead to the desired results, much like Japan experienced after its 50% devaluation against the Dollar beginning in 2012.