Falling Dollar? It Depends on Your Index

Commentary by Bob McTeer

Source: Forbes

When the Federal Reserve adopted a super easy monetary policy in response to the financial crisis and recession, many analysts, along with their predictions of hyper-inflation, predicted a collapse of the dollar. Furthermore, many advocated measures to strengthen the dollar in foreign exchange markets. It was widely believed that what we needed was not a weak dollar, but a strong dollar. Larry Kudlow and many of his guests pined for “King Dollar.”

My position back then was that we need a strong dollar in normal times to support a high standard of living, but, during a steep recession and anemic recovery, a strong or stronger dollar would inhibit the recovery. My line was that a strong dollar is desirable eventually, but not during a recession or weak recovery. I compared my position on a strong dollar to St. Augustine’s position on chastity. “Lord, make me chaste, but not just yet.”

I didn’t expect my position to remain the same years later, in May 2014, but it has because the economy is still struggling. And, the dollar is once again in the news. As long as the DXY dollar index remained at 80 or above, I could truthfully say that the dollar hadn’t weakened over this period. But, lately, it has slipped below 80 a few times and once again has the world’s attention.

Given this renewed focus on the dollar, let me remind you once again that the DXY trade-weighted index for the dollar is a mighty poor index to remain the index of choice on financial TV. For example, it overweights the Euro zone and gives no weight at all to China and Mexico, two of our largest trading partners. In general, there is very little correlation between the DXY weights and various countries’ share of our imports and exports.

According to Wikipedia, there are only six currencies in the DXY basket:

  • Euro, 57.6%
  • Yen, 13.6%
  • Pound Sterling, 11.9%
  • Canadian dollar, 9.1%
  • Swedish krona, 4.2%
  • Swiss franc, 3.6%.

That’s it. Only six currencies. Again, no China, no Mexico, no South American currencies, no Asian currencies other than the yen.

According to the Federal Reserve’s H.10 series on exchange rates and weights, the Euro zone has a total trade weight (imports and exports) of 16.2%, not 57.6%; the U.K. has trade weights of 3.4%, not 11.9%.

China’s total trade weight is 20.81%, Mexico’s is 11.67%, and they aren’t even in the DXY basket.

One reason the DXY has slipped lately is that it does not include the depreciating Chinese yuan, which would push the dollar index up if it were included. Both the Board of Governors’ “broad” dollar index and “major country” index do not show a recent weakening of the dollar. One has to wonder why those indexes are not used while the DXY remains the favorite of financial television.