Economic Growth and currency depreciation economic, because, investor, increase, currency

torontoanalyst

"An increase in US economic growth would weaken the dollar because the economic growth would stimulate the demand for imports"

Wouldn't the investor want to invest in economies with high economic growth?

busterbluth

I think in the short term , you're right .

But in the longer term , people are better off economically , want to buy cheaper foreign goods and gradually the dollar weakens

mengxu

This is complex, and I don't think I would have answered this intuitively correctly, but after thinking about it for a minute, you have to remember that investing in the economies with high economic growth is a separate question from what will happen to the currencies of those economies..

Basically, from a foreign investor's perspective, there are two sources of return. One is the LMR or local market return on the assets they invest in... these will generally grow when there is economic growth, and yes, you'd usually want to invest in them.

However, there is also the LCR or local currency return. So the economy may grow, that will weaken the dollar, and the weaker dollar will (for a foreign investor) reduce the total return of the investment. Will it reduce it so much that it's not worth investing in??? That depends on two things: 1) whether the weakening in the dollar is so dramatic that it outpaces the return on local assets (often it won't), and 2) whether there are more attractive investments elsewhere (like the investor's own stock market, or even the investor's own RF asset).

So the effect of growth on the dollar and the effect of growth on US investments are separate processes, although both need to be considered when evaluating the investment in an internationalized setting.


As for exports vs imports... there is a balancing act. As people curtail spending in the economy, imports drop in the US because we buy less junk from China. Once we start to feel more flush, we start to import more. That should push the dollar down. But then a down dollar means our exporters are more competitive, so that will start to push the dollar up. Part of the long term trend in the currency depends on whether we are importing more or exporting more over time, as well as how attractive our (increasingly globalized) companies are as sources of profit. Of course, currency cross rates are relative comparisons, so right now the strengthening dollar has a lot to do with the fact that 1) Europe is a mess, and 2) the emerging markets, even to the extent that they are growing, just aren't all that big and liquid, compared to USD.

So it's a big mess, and don't beat yourself up if it's hard to separate out the short term from long term effects.



Edited 1 time(s). Last edit at Friday, May 28, 2010 at 02:08PM by bchadwick.