By David McMahon - Analysis
NEW YORK (Reuters) - A slowdown in U.S. productivity growth poses a long-term challenge to the U.S. dollar and is adding to the difficulty of financing a gaping trade deficit.
The dollar has fallen to a record low against the euro this year, weakening against most other currencies along the way, as U.S. economic growth slows and economies in Asia and the Europe motor ahead.
Signalling that the dollar’s woes may be far from over, U.S. productivity growth, the bedrock of a strong U.S. economy and dollar in the 1990s, has slowed for three straight years and is showing some signs of a permanent downshift.
A slowdown in the U.S. economy’s cruise speed over the longer term could reduce the attractiveness of U.S. assets to foreign investors and make it harder to finance a bulging trade deficit, which last year rose to a record $765 billion.
“As productivity growth declines, the most important incentive to invest in dollar-denominated assets is no longer in place,” says Hans Redeker, currency strategist for BNP Paribas in London. “I‘m afraid the dollar’s malaise is far from over.”
The U.S. economy grew at an annual rate of just 1.3 percent in the first quarter of 2007, the slowest of all 43 countries tracked by The Economist magazine.
The Organization for Economic Cooperation and Development last week lifted its forecast for global growth in 2007, but said the economies of Europe and Japan were on track to outpace the U.S. for the first time in 16 years.
There are some signs that this is not a temporary phenomenon. Most notably productivity, which determines the speed limit of an economy’s growth over the longer term, is showing signs of slowing in the United States just as it may be poised to edge higher in Europe and Japan.
U.S. labor productivity growth slowed for a third straight year in 2006, and at 1.4 percent, was the lowest in a decade, the Conference Board estimates.
Some of this slowdown is to be expected, since productivity growth tends to moderate in late stages of economic growth cycles. Companies are cutting back production in response to slowing demand but keep most of their staff on the books.
Still, there are good reasons why this may be a more lasting trend. Economists generally agree that an acceleration of U.S. productivity growth in the 1990s was driven by a relatively quick adoption of new information technologies such as the Internet..
The International Monetary Fund noted in its latest survey of the global economy, however, that the benefits of the technology revolution for the United States may have largely run their course, while Europe and Japan, which lagged the United States in adopting these technologies, are catching up.
That bodes ill for the dollar, which has historically tracked growth in productivity over the longer term.
“There’s a cyclical switchover and I think there’s some evidence of a longer-term secular switchover in growth too, which would essentially mean we’re in for a period of sustained dollar weakness,” said Menzie Chinn, an economics professor at University of Wisconsin who specializes in exchange rates.
According to one study by the Federal Reserve Bank of New York, rising U.S. productivity explained nearly two-thirds of the dollar’s appreciation against the euro and three-quarters of its rise against the yen in the 1990s.
Deutsche Bank says it reckons that the U.S. economy’s “trend growth,” or expected long-term rate of annual growth, has slowed to about 2.75 percent, from around 3.5 percent in the 1990s, the beginning of a boom in IT-related investment.
In contrast the bank sees potential growth in Europe and Japan drifting up to at least 2 percent, halving the United States’ growth premium to around 0.75 percent.
“The bad news on potential growth from population aging in the euro area and Japan was probably excessively priced into financial markets, while in the U.S. it is likely that the slowing in potential growth has not been priced in yet,” analysts at Deutsche Bank wrote in a recent report.
Partly due to the decline in the United States potential growth rate relative to the rest of the world, Deutsche sees the dollar declining another 8 percent over the coming two years against a basket of its trading partners’ currencies.
The dollar has already declined 31 percent over the past five years against an index of six major currencies .DXY.
Economists at Merrill Lynch concur that the center of gravity of global growth is shifting, writing in a recent note to clients: “The U.S. is passing the growth baton to the rest of the world in a long relay race, not a sprint.”
A divergence in global growth is also leading some money managers to bet on further declines in the dollar, particularly against currencies in Asia, which is showing signs of becoming less dependent on the United States as a growth engine.
“Asian currencies in particular are benefiting from a delinkage of what is happening in the U.S.,” says Michael Hasenstab, fund manager at Franklin Templeton Investments, which manages $576 billion of assets. “In the past it was always the U.S. sneezes and the world catches a cold, but domestic demand and trade linkages in Asia are helping delink the region from the economic slowdown in the U.S.”