Has The US Dollar Topped Out, Or Headed Much Higher? by Gary D. Halbert
FORECASTS & TRENDS E-LETTER
by Gary D. Halbert
April 21, 2015
IN THIS ISSUE:
- US Dollar Has Risen Over 20% in the Last Year
- The Really Bullish Case For the US Dollar
- Surging Dollar Boosts Europe, Japan & Others
- Who Pays Income Taxes in America & Who Doesn’t
- How Government Disguises the Real Level of Taxes
The US dollar’s value has been on a tear since last summer, with the greenback’s value surging more than 20% against a basket of major foreign currencies. Reasons for the dollar’s sudden strong advance vary widely, but include the following among others:
- The US economy is faring better than most other developed economies, and foreign investors have to buy dollars in order to participate.
- The Fed is expected to raise short-term interest rates this year, and higher rates historically lead to a stronger currency.
- US stocks and bonds have been the leaders in market returns in recent years, and foreign investors continue to flock to them, creating more demand for dollars.
- Global tensions and concerns are rising in many parts of the world, and foreign investors are seeking a safe-haven in which to park their money.
- Basically, the US is the least worst of a bad lot when it comes to where international investors want to stash their money.
For these reasons and others, international capital has been flowing into the US at a near-record rate since last summer. This has definitely boosted the value of the US dollar since last July and may continue to do so. But questions remain.
The first question is whether the strong rise in the US dollar will continue? There are some compelling arguments that it will, as I will discuss below. Yet in March of this year, the US dollar turned lower. So the next question is, whether the recent downturn in the US dollar is a real change of trend? I’ll offer an opinion as we go along.
Following that discussion, we will delve into the latest data on who pays income taxes and who doesn’t. The numbers may surprise you, especially given that the Democrats want to raise income taxes on high income earners and corporations. What else is new?
US Dollar Has Risen Over 20% in the Last Year
A country’s currency is, in part, a reflection of how well or poorly its economy is doing. And, for the moment, the US is setting the pace for most of the developed world. US gross domestic product surged at a 5% annual rate from July through September, the fastest pace in more than a decade. As the recovery picked up speed in the 2Q and 3Q of last year, American employers added nearly 3 million jobs to their payrolls, the biggest gain in 15 years.
Investors around the world looking for a piece of that growth have to use dollars to buy into it. And that demand for dollar-based investments drives up the price. In the second half of last year, the dollar rose more than 16% against a collection of world currencies.
Let’s start with a chart of how much the US dollar has risen in the last year alone. The rise has been very impressive, especially in light of how much our national debt continues to rise – now above $18 trillion – the largest in American history. Let’s take a look.
Bloomberg’s Dollar Spot Index, which tracks the US currency against 10 major peers including the euro and yen, has surged 20% since the middle of 2014. The gains stalled recently, sending the Index down more than 3% in the three weeks through April 3, as Fed officials tempered investors’ expectations about the pace of interest rate increases.
Yet as you can see above, the dollar has rebounded in the last two weeks, and some analysts believe it will move significantly higher before this trend is over.
The Really Bullish Case For the US Dollar
US dollar bulls argue that there’s pent-up demand for the US currency that will lead to years of appreciation because the world is “structurally short” the dollar, so says former International Monetary Fund economist Stephen Jen and others.
Sovereign governments and corporate borrowers outside America owe a record $9 trillion in the US currency, much of which will need repaying in coming years, according to data from the Bank for International Settlements (BIS). That’s up from $6 trillion at the end of 2008.
In addition, many foreign central banks that had reduced their holdings of the greenback in recent years are starting to reverse course, creating more demand. The dollar’s share of global foreign reserves shrank to a low of 60% in 2011 from 73% a decade earlier, although it has since climbed back to 63%.
While there will continue to be short-term ups and downs caused by changes in Fed policy, interest rates and economic data releases, the major trend may well remain higher due to these larger forces combining to fuel more appreciation, so Mr. Jen believes. He adds:
“Short-covering will continue to power the dollar higher. The dollar’s strength is not just about cyclical factors such as growth. The recent consolidation will likely prove to be temporary.”
Jen predicts that the dollar will climb another 9% over the next several months, and maybe more if the Fed hikes its short-term interest rate, which I don’t expect until September at the earliest. Of course, there are still some who believe the FOMC will raise the Fed Funds rate at the June policy meeting. Should that happen, I would expect the dollar to move to new highs, if it hasn’t already done so.
Jen isn’t the only one who thinks short-dollar positions will cause the rally to extend. Chris Turner, head of foreign-exchange strategy at ING, sees the dollar surging through parity with the euro by mid-year. He said gains will be spurred by bonds from Germany to Ireland that are yielding below zero.
“Central banks are re-accumulating their dollar reserves and low, or negative, bond yields in the euro zone will probably speed up that trend,” said London-based Turner, whose bank topped Bloomberg’s rankings for the most accurate currency forecasts in the past two quarters.
Surging Dollar Boosts Europe, Japan & Others
The International Monetary Fund (IMF) revised its forecasts for global growth in 2015 and 2016 last Tuesday, considering among other things the recent strength in the US dollar and weakness in other currencies. While the IMF downgraded its estimate of US growth modestly, it actually revised upward its forecasts for most of Europe, Japan and some other countries whose currencies have weakened against the US dollar. Let’s look at the latest numbers.
The IMF left its projection for global growth in 2015 unchanged from three months ago at 3.5%. Underneath the stable forecast, however, the IMF depicts a global economy being reshaped by swings in currency markets and the drop in oil prices.
The Washington-based lender of last resort cut its US expansion forecast by 0.5% to 3.1%, still the fastest among the most developed major economies. The Japan growth outlook increased to 1% from 0.6% in January. The euro area is projected to expand 1.5% from 1.0% earlier this year as weakening currencies provide a “welcome boost,” the IMF said. Here are the latest IMF estimates for 2015 and 2016.
Elsewhere, emerging markets are showing their own mixed forecasts, with growth projected to slow to 4.3% from 4.6% in 2014, the fifth straight annual decline and the same forecast as in January.
The figures show India will grow more quickly this year than China for the first time since 1999, according to the latest forecast. The IMF predicts India will expand at a 7.5% rate this year, up 1.2 percentage points from the January forecast.
Meanwhile, China is expected to grow 6.8% this year, unchanged from January’s forecast. The world’s second-biggest economy is slowing as “previous excesses in real estate, credit and investment continue to unwind,” the IMF said.
Brazil will contract 1.0% in 2015, compared with projected growth of 0.3% percent at the start of the year. The IMF projects an even deeper contraction in Russia this year than it did in January, with output expected to shrink 3.8%.
The bottom line is that the rising US dollar has benefited most other countries which have seen their currencies weaken, thus making their exports cheaper on the world market. For the US, on the other hand, the stronger dollar has made our exports more expensive. Yet with exports accounting for only about 15% of GDP, the stronger dollar has not had a huge impact on our diversified economy.
Who Pays Income Taxes in America & Who Doesn’t
April 15 came and went last week and most of Americans who owed taxes dutifully paid them. Today, I thought we would look at the latest data showing who pays income taxes and who doesn’t. The numbers from 2014 may surprise you.
According to the Tax Policy Center, the top 1% of earners – who had so much hate directed at them when the Occupy Wall Street movement captured the media’s fancy a few years ago – pays 45.7% (almost half) of all income taxes while making only 17.1% of national income.
The top 20% of earners pay 83.9% of all federal income taxes. At the same time, they make only 51.3% of total US income. The middle 20% of earners pays only 5.9% of federal income taxes, while earning 14.8% of national income.
Meanwhile, the bottom 20%, which earns only 4.5% of all US income, pays -2.2% (yes, negative 2.2%) of federal income taxes. In other words, those in this quintile, instead of paying an income tax, actually get paid money from Uncle Sam after Washington has taken it from everybody else.
Anyone who thinks this distribution is fair should think again. The system is so steeply progressive that Karl Marx would likely approve if he were alive today!
This, of course, isn’t what we hear from redistributionists who go on and on about how “the rich don’t pay their fair share.” A Pew poll in mid-February found that 72% of Americans think many wealthy people don’t pay their fair share of federal income taxes.
An Investor’s Business Daily poll in March found that 90% of Democrats favor “raising taxes on the wealthiest Americans to pay for programs that will benefit the lower and middle classes.” So Democrats are now embracing a more full-throated kind of populism, releasing a new tax plan that takes from the richest Americans and Wall Street. Rep. Chris Van Hollen, the Maryland Democrat, is behind the proposal. You will be hearing more about it just ahead.
How Government Disguises the Real Level of Taxes
In various polls, most Americans say they believe they pay too much in federal taxes. Yet those views would be even more negative if people felt the full pain of funding the $4 trillion a year federal government. But the citizenry hasn’t resorted to pitchforks yet because politicians use “fiscal illusion” techniques to hide a lot of the costs.
Here are some of the techniques (hat tip to The Daily Caller):
- Debt. The government finances half a trillion dollars a year of its spending by borrowing. So people see the benefits of the spending, but the costs are pushed forward by deficits and debt. The government has run deficits in 85% of the years since 1930, so this is not a transitory problem but a deliberate strategy of hiding costs.
- Withholding. The federal government requires employers to withhold income and payroll taxes from paychecks, and that makes earnings disappear before workers get their hands on the cash. Withholding was introduced during World War II to make income taxes feel less painful, and thus to reduce taxpayer resistance.
- Refunds. The IRS has rigged the withholding system so that more than three quarters of tax filers get refunds every April. As a result, the government appears to be Santa Claus rather than a fiscal oppressor.
- Business Taxes. The government collects hundreds of billions of dollars a year from taxes on businesses, including the corporate income tax and the employer half of the federal payroll tax. The burden of these taxes ultimately falls on individuals, but the collection is invisible to them.
- Real Bracket Creep. Federal income taxes are indexed for inflation, but not for real economic growth. Because tax rates rise as one earns more, the system results in the government automatically and invisibly gaining a larger share of incomes over time.
- Complexity. Congress has spread out the federal tax burden across multiple different tax bases. It has also made the largest tax – the income tax – hugely complex. These features of tax design have reduced the ability of voters to understand the overall cost of government.
- Regulations. When Congress wants to confer benefits on voters, an alternative to a tax-funded program is a regulation. For example, regulations require most businesses to provide workers with health insurance and a range of other benefits. The costs of such mandates ultimately fall – in a hidden manner – on individuals in the form of lower wages and higher prices.
- Smoke and Mirrors. The government uses accounting tricks to hide costs. One is the “salami strategy,” which is used by the Pentagon and other agencies on large projects. With this technique, the full costs of projects – such as weapon systems – are only revealed one slice at a time, so that by the time the full costs are evident, the project is too far along to be canceled.
All these techniques make the “price” of government seem artificially low, such that Americans keep electing politicians who promise to give us even more of it. At the same time, fiscal illusions embolden politicians to spend money on activities that make no economic sense.
But fiscal illusion is fiscal dishonesty. Whether people believe in small government or big government, they should want lawmakers to trade-off the costs and benefits of programs in a transparent way. So one goal of federal tax and spending reforms should be to repeal as many of these illusionary techniques as possible.
I could go on (and on), but I’ll leave it there for today.
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Gary D. Halbert