Research Affiliates: Gimme Shelter: The US Dollar Trade And Its Risks

June 10, 2015

 

The U.S. current account deficit might also add to concerns about the long-run valuation of the dollar. A current account deficit suggests that the country imports more than it exports and pays for the difference by selling domestic assets to foreign investors. A significant and persistent deficit is therefore unsustainable in the long run. It might require that the dollar depreciate. Figure 3 shows that the U.S. current account is very much in negative territory. The United States has failed to close the current account deficit despite enjoying strong tailwinds from the energy sector and a weaker dollar in 2011 and 2012. This evidence suggests that, in view of the current levels of government borrowing, a strong dollar could be followed by dangerously high current account deficits.

 
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In Closing

The current foreign exchange environment offers an opportunity for U.S. investors to diversify their portfolios. The U.S. dollar appears overvalued across almost the entire spectrum of currencies; this means there might be currencies that are priced below their fundamental value. In addition, a strong dollar might impair U.S. corporate earnings, boosting foreign markets. Finally, and perhaps most critically important for long-term investors, there are returns to be harvested from investing in countries with higher cash rates. In particular, the emerging markets offer the opportunity to invest in younger economies with greater growth opportunities. The historical benefits of diversification should induce investors to consider whether it is worth concentrating their risk exposure toward the U.S. economy.

 

 

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