A Cheaper U.S. Dollar Is Good for U.S. Economy for Now

January 28, 2021

Source: Bloomberg; Data as of 12/31/20. Source: Bloomberg; Data as of 12/31/20.

Many of my friends ask me frequently: Is a cheaper dollar good or bad for us? This is a rather deep question to address but to put it simply, it is good for us for now.

The 10-year real yield, which represents our economy’s long-term growth, is now hovering around -1%. This implies that in the long term, such as 10 years, the market expects that the growth of the economy after inflation will be -1% per annum. Real yield is a better measure of the long-term prospect of the economy than gross domestic product (GDP). This is because the real yield is less affected by the artificial creation of demand, such as fiscal stimulus that greatly affects consumption, the biggest component of GDP.

Then how does the U.S. dollar value affect the real yield? A cheaper dollar means more expensive imported goods and cheaper exported goods, so a cheaper dollar expedites domestic production. On the other hand, all capital assets denominated by the U.S. dollar are less attractive to investors, so capital flows overseas to invest. Therefore, it is not easy to brand it as good or bad in either direction, but in such a long downtrend of real yield, a cheaper dollar will do more benefit than harm.

This week’s chart shows how a cheaper dollar may expedite a reversal of the real yield downtrend in the short term with a few statistical tests. First, the chart depicts the monthly time series of 10-year real yield (USGG10Y-CPI) and the Dollar Index (DXY) since late 1969. Second, a VAR test is performed in order to assess any significant role of the DXY to the real yield in the coming months.

When calculated, the VAR test shows that the dollar value affects real yield by three-month lags. In addition, the coefficient (estimate), -0.019, is negative, which means that a lower dollar value will likely result in higher real yield in three months. Third, the Granger causality test is performed to check whether the dollar value will help forecast future real yield. When completed, the causality test successfully rejects the null hypothesis of non-causality of DXY to the real yield under a 5% level of significance.

Key Takeaway

We have investigated the impact of a cheaper dollar on the real yield in rather complicated statistical methods. Still, the implication is simple: A cheaper dollar will lead to higher real yield, which proves to be good for the economy.

Tags: U.S. Dollar | U.S. economy | Economic growth | GDP | 10-year real yield | Dollar Index

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