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If you spend enough time on certain corners of certain social media sites, chances are that you’ll see someone point out that Mississippi, the poorest US state, is now richer per capita than the UK or Japan.
Some say it is a killer example of America’s exceptionalism, while others will counter that a stunning chunk of the US economy is healthcare spending, or point out that nominal GDP per capita is a flawed measure of how comfortable the median citizen actually is.
However, in his latest note, Stephen Jen of Eurizon SLJ has articulated what FT Alphaville has been quietly wondering for some time: perhaps it’s just mostly indicative of an egregiously overvalued US dollar. Here’s Jen:
The poorest state in the US — Mississippi — has a per capita dollar income that is higher than those of the UK, France, Italy, and Japan, and is only slightly lower than that of Germany. Does this make sense to you? To us, this is another proof that the dollar is grossly over-valued, inflated in part due to the super-sized fiscal program.
Some FX analysts might sneer at such a facile take, pointing to more complex econometric models that show dollar strength is entirely justified and will probably continue to strengthen. And for now, it seems the markets agree.
But Alphaville can’t shake the feeling that many of the weird phenomena — such as US gas station managers seemingly commanding bigger salaries than many European doctors, or Jane Street interns making more than the UK prime minister — are simply evidence that the US dollar is wildly overvalued.
Here’s Jen’s more specific arguments on why fiscal largesse is at the heart of the phenomenon, and why he estimates that the dollar is about 22 per cent overvalued against other G10 currencies — the most since 2002:
● American Exceptionalism not all benign. Without downplaying the unique and familiar strengths of the US, a good part of the US’ superior real GDP growth, high inflation, high interest rates, and strong dollar are a result of its aggressive fiscal posture. We have posed the rhetorical question: if the US embarked on a fiscal consolidation program to bring its fiscal deficit down from the current 6-7 percent of GDP to the Maastricht limit of 3 percent of GDP, which is what many non-European countries consider the threshold of tolerance in the absence of major recessions, what would its GDP growth rate be, and where would the FFR need to be? Where would the dollar trade?
● The US’ fiscal posture is unsustainable. Few would contest this point, yet most of the members of Congress resisted spending cuts last December. Currently, the US’ federal expenditures are around 23 percent of GDP, while its revenues are around 17-18 percent of GDP. The latter has been stable at these levels for more than three decades. The former, however, rose sharply and steadily since the early 2000s, from around 19 percent of GDP then, to 23 percent in the period between the GFC and Covid, and 26 percent average between 2021-2024. Countries operate at very different sizes of government, reflecting cultural and other differences. For example, Norway’s government expenditure has ranged between 45-50 percent of GDP, and Singapore’s government spending ratio is only around 10 percent of GDP. Those who believe in big government point out that the US’s spending is not that large compared to the European countries, but those who believe in small government point to counter-examples, like Singapore, where government services don’t seem to be compromised despite a small government presence in the economy. In any case, spending should be fully funded on average over a business cycle, whatever the level of government presence. It is not in the US. The US is not in a recession or coping with any material shock. Proponents of MMT (Modern Monetary Theory) long promoted aggressive fiscal spending financed by money printing, assuming casually that fiscal spending would easily be cut when appropriate. We are reminded that fiscal policies are not symmetrical: it is easier to spend and difficult to save. We are also reminded of a quote from President Reagan: ‘Nothing lasts longer than a temporary government program.’
● Inflation and future currency depreciation. The US has experienced cumulative inflation from end-2019 of some 24 percent, compared to 10 percent in Japan and 3 percent in China during the same period. We have previously pointed out that the differentials in price and wage inflation between countries have led to wide disparities in manufacturing costs, which are around USD53 an hour in the US, USD21 in Japan, and USD10 in China. This has put the US in a highly uncompetitive position in the goods market. No wonder the US needs high import tariffs for protection. EM investors are familiar with the linkage between inflation and currencies: poor inflation control in an EM economy usually leads to an erosion in competitiveness, which in turn compels currency depreciation to restore the real exchange rate value prior to the inflation spurt. This is precisely why inflation control has been the Achilles heel of EM for decades. The same logic, we argue, applies to the USD, especially USDAsia: the very wide gap in inflation since the Pandemic should eventually lead to currency adjustments to help restore relative competitiveness between the West and the East. Tariffs could provide temporary protection for a country that is no longer competitive. They should not lead to a further dollar appreciation but might help prevent a large depreciation in the dollar, in our view. Further, Japan’s per capita income, being only one-third that of California, is largely a result of the 45 percent rise in USDJPY during this period. Is Japan really as poor as these numbers show? The answer is obviously no.
● Our valuation model tells the same story. [ . . . ] The dollar index is about 22 percent over-valued against G10 currencies. The size of the dollar over-valuation is quite significant compared to history and its duration. It is the highest overvaluation against G10 since 2002. It is also remarkable that, in bilateral terms, the dollar looks overvalued against a very wide range of currencies. On our measures, the dollar is 15 percent overvalued against the EUR, 24 against GBP, 9 percent against CNY and 53 percent against the JPY.
If this is true, what might trigger a reversal? Who knows. Fiscal retrenchment looks unlikely, with DOGE now apparently reduced to a glorified Signal messaging group. In the meantime, let us know if you need someone to tend the pumps at a gas station near Jackson, Mississippi.
Further reading:
— How to devalue the dollar (a guide for Trump)
Read the full article here