US Dollar Poised to Fall Sharply

January 2020

The US dollar is extremely overvalued and if history is any guide it is poised for a substantial multi-year fall. According to our Purchasing Power Parity (PPP) valuations, it is now overvalued against every major currency in the world. Since the end of the Second World War, there have been three previous instances of extreme dollar overvaluation: the late 1960s, the mid 1980s and the early 2000s. In the late 1960s, the overvaluation was caused by high inflation within a fixed exchange rate regime (“Bretton Woods”); in the mid-1980s, the overvaluation was caused by Fed policy under chairman Paul Volcker that saw rates rise to double digits in order to squeeze inflation out of the system (“Volcker Shock”); and in the early 2000s the overvaluation was driven by the tech boom drawing in capital to the US (“Productivity Miracle”). One thing that all three of these prior episodes of dollar overvaluation have in common is that they did not last. In each case, the US dollar, as measured by its trade-weighted exchange rate against a basket of its peers, saw a massive depreciation over a multi-year period. These historical precedents suggest that the US dollar is poised for a substantial, multi-year fall.

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    • According to our Purchasing Power Parity (PPP) valuations, USD is extremely overvalued

    • Chart 1 shows the breadth and extent of this overvaluation

    • USD currently overvalued against all other major currencies

    • Corroborated by Bank for International Settlements trade-weighted USD Real Effective Exchange Rate (Chart 2) which is above its early 2000s peak

    • There have been three similar overvaluations in the past, each ended by large and protracted falls in USD against trade-weighted peers:

      • In the 1970s USD fell > 30% in real terms over 9 years

      • In the mid-1980s to mid-1990s USD fell > 35% in real terms over 10 years

      • In the 2000s USD fell > 25% in real terms over 9 years

      • If history is any guide, USD appears poised to suffer a substantial, multi-year fall


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