US Dollar history since 1999 and some predictions

This is a graph of the US Dollar Index since 1999.

Annoyingly, the St Louis Fed "FRED" online tool does not have a USDX graph to check, so I had to add in all the different currency values onto a spreadsheet and then apply all the various weightings. This graph begins in 1999 because the Euro was not around before then and, while I'm sure there are equations and whatnot to cover this change, I haven't found them yet!

But as you can see the US Dollar reached its peak at around the same time as the dotcom boom went bust in 2000-2001. It fell steadily to around 2005, when it regained value somewhat and then fell further until early 2008. Of course the steep rise in mid-late 2008 was due to the effects of the credit crunch and a small plateau of sorts developed before further devaluation began and lasted until November 2009, when it began to rise again. The figure for May 2010 was 85.33.

One of the predictions I made for 2009 was a devaluation of the currency to below 60 on the US Dollar Index. Of course this didn't happen but I'm reasonably confident that it will devalue below 60 at some point. The long term trend is downwards, with a high  of 118.98 in February 2002 and a low of 72.11 in April 2008 seeing a maximum decline of approximately 40% (though in May 2010 the decline from February 2002 was around 28%).

At the moment, consumer prices in the US have declined for two months and the effect of the Obama stimulus plan has begun to wear off, which means that we are heading for a more muted economic performance. I think GDP in Q2 2010 will be very low and I am expecting at least one quarter of negative growth this year. At best we'll see some further deflation and at worst a second credit crunch to rival Q4 2008, which means that investors are probably going to push the Dollar up again as they run away from stocks - a process which has already begun if you look at the far right hand side of the graph.

The only fly in this predictive ointment is European GDP growth in Q2 2010. I believe that EU growth will be higher than US growth during this period and investors will be surprised by European economic strength - to the point where yields on PIIGS bonds will drop. How long this will last I don't know, but monetary conditions in Europe in the last three months have certainly been very strongly inflationary (Switzerland will head them all, whilst Greece will be reasonably poor) whereas monetary conditions in the US have more or less been neutral (and tending deflationary).

Follow-up on real interest rates

I obviously picked the right time to ruminate on real interest rates. As regular readers know, I posted an article the other day that examined the impact that real interest rates would have on various economies.

I placed Germany in "Group 2", meaning that real interest rates had decreased moderately and this would help boost any economic output. Well the BBC has just reported that the German economy grew by 0.2% in Q1 2010. Eurostat has interpreted these figures to be a 1.5% growth in GDP over the past 12 months.

I placed Greece in "Group 4", meaning that monetary conditions had sharply deteriorated and that an increase in real interest rates would act to dampen any economic growth. The Wall Street Journal has reported Greek GDP declined by 0.8% in Q1 2010, while Eurostat sees it as a decline of 2.3% in GDP over the past 12 months.

You can download the Eurostat report (which the BBC and WSJ have reported from) here (pdf, 122kb).

Other "Group 2" nations include Spain (-1.3% but better than the previous 3 quarters), France (1.2% growth), Italy (0.6% growth) but nations like Ireland and Sweden have yet to have their GDPs reported. The Euro area itself has grown by 0.5%, which is good news, and has grown faster than the European Union generally (0.3% growth).

"Group 1" nations - those whose real interest rates were dropping too quickly and were in danger of inflation, include the UK, whose economy declined by 0.3% (thus developing into a "stagflationary" environment) . Switzerland and Iceland have yet to report.

The sole "Group 3" nation - Poland - has yet to report GDP too.

The fastest growing EU nation was Slovakia with 4.6% growth. Latvia is the worst, with -5.1% (following on from -17.1% the quarter before)

Some predictions using real interest rates

My study of real interest rates has been continuing, though without any publishing on this blog due to data collection. There are some predictions though which I have decided to publish today.

I've broken up nations into four groups.

Group 1 - Plunging real interest rates. These are nations whose monetary conditions have dramatically changed over the previous six weeks to promote inflation. These nations are:

• Britain
• Argentina
• Brazil
• Iceland
• Switzerland
• Mexico
• China
• Russia
• Turkey
  

Now of these nations, the one with the lowest CPI is Switzerland, which means that the inflationary growth will not be as serious, while Turkey and Argentina already have high levels of inflation. High inflation levels are bad for an economy because they act to distort prices which, in turn, leads to more inaccurate "money direction" - the choices money holders have in spending or saving or investing or borrowing currency. This inevitably leads to a "peak" in growth, followed by a trough - inflation usually precedes a deflationary economic downturn.

Group 2 - Real Interest rates dropping moderately. These are nations whose monetary conditions have favoured economic growth over the previous six weeks.

• Japan
• Canada
• Euro Area
• Australia
• Ireland
• Spain
• Germany
• France
• Italy
• Sweden
• India
• New Zealand
  

While inflation may result from these monetary conditions such an increase is not likely to be serious. While these conditions do not guarantee economic growth they do act to either improve growth already occurring or to limit any contraction. Of these nations, Ireland is the only one with a contracting economy experiencing deflation, so it is likely that Ireland will experience only moderate contraction and more stable prices in the coming months. Conditions in the Euro Area are improving, which should affect the PIIGS in a positive way. While India's real interest rates have improved moderately, very high inflation continues to afflict them and there is evidence from my data to suggest that India is likely to have some form of economic contraction (ie either a downturn or lower growth rates) soon. Of the nations on this list, Japan and Germany, with price changes close to zero, are more likely to experience sustained growth.

Group 3 - Real interest rates increasing moderately. These are nations whose monetary conditions have favoured economic contraction over the previous six weeks.

• United States
• South Korea
• Poland
  

Again this is not a prediction of economic decline but a contractionary effect upon growth/decline already being experienced. I have collected more data on US CPI and interest rates than any other nation and the data suggests that conditions in the US are not improving. Growth in GDP for Q1 2010 was 3.2%, following on from 5.6% in Q4 2009, which shows that the Obama stimulus of 2009 has passed its peak and is headed on its way down. Real interest rates in the US declined considerably between July and December 2009. In fact "considerably" is too conservative a word to use - real interest rates declined from 5.7% to 0.62% over that six month period. The US would be in "Group 1" in December last year, which indicates that the US economy is beginning to slow down. Considering the speed of the decline and the growth experienced in Q4 2009 and Q1 2010, I would be very surprised if growth ended up exceeding 1.0% for Q2 2010 (which is now).

Group 4 - Real interest rates increasing substantially. These are nations whose monetary conditions have seriously deteriorated over the previous six weeks.

• Greece

Greece has suffered mainly from the market's fear of a sovereign debt crisis - and such a fear is not unfounded. With increasing austerity measures being put into place, Greece's economy looks set to contract - ie shrink - some time this year. Inflation in Greece is still running a little high (3.9%) but increases in bond rates have more than exceeded this amount. Inflation in Greece is likely to turn into deflation as soon as the economy begins to shrink. Growth in the Euro Area, though, is likely to moderate any Greek downturn (and also help Ireland stop its current economic decline).

And that's Stephan Bibrowski in the picture.

Is the US economy slowing?

Well maybe according to my study of real interest rates. Here we go:

In the wonderful "Spread Sheet"^TM screenshot you see above, you can see the columns marked 10 year bonds and inflation - all of which were derived from data from The Economist magazine (I do have better data sources for the US, namely this and this, but I use The Economist as a way of comparing rates all over the world). Weekly Real Interest rates can be seen there in column D, which are essentially (Bond Rate) minus (Inflation Rate). Now since real interest rates go up and down because the bond market goes up and down, I've focused mainly upon column E, which is the average Real Interest Rates of the previous 6 weeks. Now Column F looks at the changes over the six weekly period and we see that things were going along quite swimmingly on 2010-03-25 but have hit a wall in the two weeks since then. From dropping to a 1.00% real interest rate on 2010-02-25, rates have increased to 1.40% since then.

The data shows that this increase in real interest rates is due to two things - a drop in inflation (from 2.6% to 2.1%) and an increase in bond rates (from a low of 3.62% to 3.86%). In fact 10 year bonds passed the 4% barrier on 2010-04-05, which was the first time since 2008-10-31. There are probably multiple reasons for the increase in bond rates - certainly the booming stockmarket could be one as investors offload safer assets to buy shares, and the Wilshire 5000 looks like this:

(image from here)

...which shows a nice increase in broad share prices since early February, the period in which real interest rates have begun to increase. The US Dollar index hasn't gone anywhere, which indicates that people aren't selling off their US Dollar holdings to buy overseas bonds.

Certainly the situation looks like either a return to the low-inflation growth experienced in the late 90s or else is a harbinger of a slowdown - inflation has crept up and has peaked and is now heading down the other side. The pessimist in me sees this as a more likely scenario than a low-inflation boom - after all the rising tide of Obama's stimulus has to return back to the sea eventually, and this is usually what occurs when any Keynesian stimulus program is enacted.

The third possibility is that it is just a minor uptick, as I theorise here, except that the "uptick" has gone up further than it did a week ago.

US Real Interest Rates: 2003 - present

I'm disappointed in you all. None of you has contacted me and asked me about my real interest rate statistical series. I mean, what am I doing, blogging for no reason? Why don't you all go and Well of course the reason for this oversight (ha ha I'm such a good comedian) is that I've been rejigging my methodology to take into account long term rates rather than short term ones - which was the problem with my previous series. Since I calculated using 10 year bond rates, every week was a new beginning or a new end for Greece or Ireland or whatever. So I've put the series into recess until I can produce something of quality that can actually mean something.

In the meantime I have tracked US real interest rates back to 2003 using data here and here. Then I put the data into something called a "Spead Sheet", which is this amazingly new office software which I have never used before until now, and begun tinkering with the equations and working out yearly inflation rates and so on. In order to come up with the raw data I first measured year on year US inflation for each month of the year back until 2002 (for 2010-02-01, the inflation rate was 2.21%). Then I measured the average 10 year bond rates over the previous month to align the inflation rate with the average 10 year bond rate (for 2010-02-01, the average 10 year bond rate was 3.73%) and I then subtracted the inflation rate from the bond rate to discover the real interesr rate for that month (for 2010-02-01, the real interest rate was 1.52%).

Anyway so here's something called a "Graph" that I made up.

As you can see I'm hardly the spreadsheet maven. The X-axis is supposed to be dates from 2003-01-01 to 2010-02-01 and "column G" is supposed to read "Real Interest Rate". Nevertheless I was able to do a screenshot and then use The Gimp to graffiti some words onto it. They are:

Too Low: During this period of the US economy, real interest rates barely exceeded 2% and even dropped into negative territory. During this period, the US economy was simultaneously recovering from the dotcom crash and investing in the subprime market. It was during this period that the medium-term seeds of economic destruction were planted in the field of financial services and fertilized by the Fed... or something like that. Anyway this is the period I have repeatedly identified as the one in which the Fed under Greenspan basically lost its marbles.

Too Little: Finally the effect of interest rate rises begin to impact the real interest rate. It is around this point that the property market reaches its peak value, but the effect of these higher real interest rates is not enough to either moderate growth or prevent the crash that is to come.

Too Lazy: Like a kid lying on a couch in front of the television playing on his XBox, so too does Ben Bernanke completely ignore reality. Inflation has spiked up considerably and neither the Fed nor the market seems worried. Money sloshes around like bilge water in a ship sailing the wide accountant-sea. Halfway through this period was when Bear Sterns collapsed and then suddenly the market decided it wasn't happy any more. Comic Sans is, of course, the lazy font, which is why I use it.

Too Late: Economy collapses and financial armageddon hits, thus bringing us back once again to the point of no return. Bernanke and the Fed, reacting to the fire in the financial field, lowers rates but, alas, is too late: the field is burning down, the ship is sinking and the Xbox has frozen. Interest rates can't be lowered any lower because of some strange mathematical rule, which means that everybody is desperately saving. 10 Year bond rates drop to a low of 2.42% in January 2009 but deflation has set in, which increases real interest rates to 5.7% by July 2009. Naturally this is the time to use a bold serif font with exclamation marks to highlight the seriousness of it all.

Now the uptick at the end is where we are now. It remains to be seen where this uptick will lead. If we are going to have a double-dip recession then deflationary pressures are beginning to hit again (inflation was 2.78% in December, but 2.21% in February) and we can expect a further rise in that line. Sadly, the line is too near the zero mark as it is, which means that it could turn back into negative territory again - a move which would precipitate and encourage an economic drop later on.

Personally I think the Fed should keep real interest rates between 2-3% over the next twelve months to prevent either an inflationary boost or a deflationary (antonym of boost). Keeping real interest rates in the "middle" like that would result in stagnation which, of course, is probably the best we can hope for.

Current Real Interest Rates

* Source: The Economist (2010-02-04)
http://www.economist.com/markets/indicators/displaystory.cfm?story_id=15457236
http://www.economist.com/markets/indicators/displaystory.cfm?story_id=15457172
** 3 month bonds
*** Source: The Economist (2009-11-05)
http://www.economist.com/markets/indicators/displaystory.cfm?story_id=14816582
http://www.economist.com/markets/indicators/displaystory.cfm?story_id=14816566
† Indicates what effect the change in real interest rates has had on the economy. Any movement ≤ ±0.1% is considered "stable"


Real Interest Rates measure saving vs spending conditions. The higher the rate, the more saving is encouraged; the lower the rate, the more spending is encouraged. Changes in real interest rates over time can indicate changes in economic conditions.

Comments

Monetary conditions in the United States have now eased to the point that, by one measurement, real interest rates are now negative. As I pointed out just after Christmas, the speed at which real interest rates have plummeted in the United States indicates both an increase in 2009 Q4 GDP for that quarter (I predicted +3%, but preliminary figures showed an increase of 5.7%) and the beginnings of a dangerous inflationary environment in the near future. This means that 2010 in America is due for higher inflation and higher interest rates. the question is - how much will economic growth be impacted by the Fed's increase in rates (or maybe even it's desire to ignore growing inflation)? I don't think the global financial crisis is over yet by a long shot, and Q4 performance is not indicative of what is in store for 2010. Unemployment in January 2010 dropped, which indicates that growth in January has continued at the very least. My prediction is that at least one quarter of 2010 will be negative growth.

According to this measurement, the US is currently experiencing negative real interest rates (using the effective federal funds rate as a benchmark rather than 10 year bonds). Negative interest rates can also be seen between 2002 and 2006 - the exact period which created the bubble environment that helped caused the crisis in the first place. This measurement indicates that Real Interest Rates in the US (based upon the Federal Funds Rate, rather than Ten year bonds as per my measurements) are around negative 2.7 percent.

Here's the data (courtesy St Louis Fed) and the equations:

DFF (Interest Rate)
DFF 2009-12-01 0.13

CPIAUCSL (Inflation)
CPIAUCSL 2008-12-01 211.577
CPIAUCSL 2009-12-01 217.541

(217.541 - 211.577) ÷ 211.577 x 100 = 2.82%

Interest Rate - Inflation = Real Interest Rate
0.13% - 2.82% = - 2.69%

Monetary conditions in Ireland have eased somewhat in the last three months, with real rates dropping from 11.24% to 9.84%. Nevertheless, the rate is still exceptionally high, due to the combination of high bond rates (compared to other nations in the Eurozone) and substantial deflation. Ireland is hardly "out of the woods" yet, but it seems likely the worst may be over. An austerity budget plus being part of the Eurozone means that Ireland's recovery is dependent solely upon an increase in Eurozone demand for its future economic growth.

Australia's monetary conditions have also eased in the last three months, though nowhere near as much as other nations. Australia's Reserve Bank has stopped raising interest rates for now, but contractionary monetary policy is likely to be maintain into 2010. GDP growth for 2009 Q4 should be broadly positive.

Recent market activity regarding Greece has raised bond levels to the highest in the Eurozone. This means monetary conditions in Greece have become contractionary. Greek GDP for 2009 Q4 should be low but I expect 2010 Q1 GDP levels to be negative.

Iceland has finally emerged from its negative interest rate environment but this will be accompanied by a continual drop in GDP and a rise in unemployment.

Real Interest Rates in India have plummeted from -3.93% to -7.32% in the last three months. This is due to a burst in inflation. Economic conditions in India are not served well by having substantial negative interest rates, and an increase in rates to control inflation is likely.

Euro Area interest rates have dropped in the last three months, indicating that GDP increase is likely, along with a drop in unemployment. Unlike the United States, interest rates in the Eurozone are still positive, which means that growth is more likely to be lower than that of the US, yet more sustainable since investment bubbles and inflation are less likely to occur in economies with positive real interest rates.

Germany has the lowest real interest rate of any nation in the Eurozone, which should help boost domestic demand (a good thing for an export-dependent country suffering from the global financial crisis)

---

Current Real Interest Rates

* Source: The Economist (2009-12-17)
http://www.economist.com/markets/indicators/displaystory.cfm?story_id=15127387
http://www.economist.com/markets/indicators/displaystory.cfm?story_id=15127442
** 3 month bonds
*** Source: The Economist (2009-11-05)
http://www.economist.com/markets/indicators/displaystory.cfm?story_id=14816582
http://www.economist.com/markets/indicators/displaystory.cfm?story_id=14816566
† Indicates what effect the change in real interest rates has had on the economy. Any movement ≤ ±0.1% is considered "stable"

Real Interest Rates measure saving vs spending conditions. The higher the rate, the more saving is encouraged; the lower the rate, the more spending is encouraged. Changes in real interest rates over time can indicate changes in economic conditions.

Comments

Since November, real monetary conditions have improved markedly in the United States, dropping from 4.85% to 1.79%. This improvement has come solely from an increase in inflation, rather than any decrease in rates, which have remained steady during this period. With conditions this positive, we can probably expect 2009 Q4 GDP to be around +3%. The decrease in real interest rates to such a low level indicates that inflation is finally on the rise, which means that the Federal Reserve is likely to push rates up in 2010, or else run negative real interest rates to try to boost the economy - a process which would end in disaster. The speed at which real interest rates have dropped in the US is an indicator of a dangerous inflationary environment in the near future.

According to this measurement, the US is already experiencing negative real interest rates (using the effective federal funds rate as a benchmark rather than 10 year bonds)

10 year Bond rates in Ireland have plummeted from 5.04% to 4.73% in one week, pushing real interest rates down from 11.64% (in November) to 10.43%. This is an indicator of the market's response to Ireland's horror budget cuts and the belief that Irish government bonds are not as risky as they once were. Nevertheless, deflation reigns supreme in Ireland and monetary conditions are still awful. Ireland will have to rely upon a recovery in Europe to boost demand for its goods which will, in turn, act to inflate prices (and thus lower real interest rates).

In response to its economic crisis, Iceland chose to inflate rather than protect their currency. The result has been high levels of inflation along with growing unemployment, though by deliberately debasing their currency they delayed the inevitable economic crash. Now that delay is over. With real interest rates near zero (but still negative), monetary conditions have tightened as interest rates finally begin to lower inflation. Iceland's economy is beginning to seriously contract as a result.

Monetary conditions in Japan have stagnated somewhat, leading to an increase in real interest rates since November. This has led to the BOJ keeping interest rates at a record low and the government promising $81 billion in stimulus. My solution would be for the BOJ to create lots of money by fiat and use it to pay off government debt, which would a) help fix deflation, and b) help reduce government debt. Japan needs to increase domestic consumption rather than rely upon exports to help fix their economy.

Euro Area monetary conditions have improved steadily since November, indicating an improving economy. In November, the Euro Area had better monetary conditions than the US, but the increase in US inflation has reversed this situation. Like the US, Euro Area inflation has increased, but not by as much. As real interest rates drop, the ECB will begin to increase rates.

Despite budget problems in Greece and Spain, real interest rates in these two Euro Area countries has improved.

Both Australia and New Zealand have had stable monetary environments since November, indicating a move towards a neutral monetary stance on behalf of their central banks.

---

Current Real Interest Rates

* Source: The Economist (2009-12-10)
http://www.economist.com/markets/indicators/displaystory.cfm?story_id=15066159
http://www.economist.com/markets/indicators/displaystory.cfm?story_id=15073949
** 3 month bonds
*** Source: The Economist (2009-11-05)
http://www.economist.com/markets/indicators/displaystory.cfm?story_id=14816582
http://www.economist.com/markets/indicators/displaystory.cfm?story_id=14816566
† Indicates what effect the change in real interest rates has had on the economy. Any movement ≤ ±0.1% is considered "stable"
†† Newly added to list

Real Interest Rates measure saving vs spending conditions. The higher the rate, the more saving is encouraged; the lower the rate, the more spending is encouraged. Changes in real interest rates over time can indicate changes in economic conditions.

---

Current Real Interest Rates

---

Current Real Interest Rates

---

Current Real Interest Rates

Current Real Interest Rates

Current Real Interest Rates

Sources to click on:

10 Year Bond Rates
Inflation Rates

Edit:

2009-11-20: Figures on Sweden, Switzerland and Mexico were messed up by me.