"Kee" Points with Jim Kee, Ph.D.

The Federal Reserve is downgrading its 2015 US GDP forecast to 2.5%, and that is consistent with the lower end of what I see as the broad consensus 2.5%-3% range. First quarter data (manufacturing, housing, etc.) continue to be soft, which is expected both because of historical first quarter GDP patterns (first quarter tends to be low) and because of the dollar’s sharp rise since May, which is hurting US international competiveness, at least temporarily.


I say “temporarily” because the peer-reviewed research that I have seen (as well as research I have done during my career) suggests that most currency-driven export booms are temporary. The general pattern is (a) a country devalues its currency, (b) exports accelerate over the next year, (c) after two years global prices have adjusted to offset the decline in exchange rates, and (d) so in the longer-term the impact of a cheaper currency on a country’s export competitiveness is nil.


In fact, falling currencies can ultimately hit a crisis point at which confidence in the currency collapses and capital flees to safer havens. This occurred throughout Asia in the late 1990s as Thailand, Malaysia, Korea, etc., devalued their currencies by abandoning their exchange rate pegs. Analysts and strategists at the time forecasted export booms in those countries that never materialized. That is why I am encouraged when a falling currency like the euro starts to bottom and rebound. I don’t know the level of the euro which would represent more collapsing confidence than European Central Bank easing, and I don’t think anybody else does either. One of my former Auburn professors was noted international monetary theorist Leland B. Yeager, who had retired from the University of Virginia before coming to Auburn. Yeager drilled into me the idea that discussing “equilibrium exchange rate levels” in a world of fiat (unbacked) currencies was somewhat preposterous. I’m not as dogmatic on the issue, but Yeager’s graduate seminars on this topic from over 20 years ago still influence my thinking.


More to the point for investors, the strong dollar’s negative impact on the earnings (profits) of export-oriented US companies has shown up and should continue for another quarter or so. But keep in mind that the dollar’s attractiveness can actually offset the negative impact of lower exports on profits through multiple expansions – the market pays more for a given dollar’s worth of earnings. That’s a point made recently by Jason Trennert of the research firm Strategas, and I think there is ample evidence to support it in the historical data.


But back to the economy, in order to get a quick read on growth I tend to watch economic indicators like the Conference Board’s Leading Economic Index (LEI) more closely than I used to. That’s because conventional forward-looking indicators like credit spreads, yield curve slopes, etc., are being distorted by central bank policy, so their information content isn’t as useful for forecasting purposes as it used to be. They used to beat the LEI hands down, but not right now. Last week’s LEI showed a .2% increase in February, which is consistent with continued, modest growth.