Customer Reviews

Making Sense of the Dollar: Exposing Dangerous Myths about Trade and Foreign Exchange (Bloomberg)

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Foreign exchange is a treacherous subject to navigate, difficult to predict and analyze, and most often left to expert traders and strategists. Yet that is no justificaiton for ducking out, since it is such a critical lynchpin of the entire system of global economics and internatinal relations.

Marc Chandler's book takes the bull by the horns. The author addresses his topic in a compelling prose style, which communicats effectively with non-economist readers, while providing ample fodder for the most informed professionals. Chandler's lucid voice steers the reader gently through the maze of trade accounting, globalization, labor markets, monetary policy and speculation, interspersing nuanced observations and discussions with simple economic explanations of how goods and money flows traverse the world.

In order to frame its message, the book uses a provocative format: it challenges a handful of forex myths, peeling back the layers of concepts frequently taken for granted as the common wisdom. For example, at the heart of the arguments, one particular chapter is bound to command attention. Is the demise of the dollar, and its threatened standing as the world's reserve currency an inevitability, as so many dollar bears have predicted in recent years? Chandler's response is a resounding no, citing, "the unique characteristics of America, such as its political stability, the depth and breath of its US Treasury markets, and its status as a superpower." He goes on to describe the dollar's other key attributes, such as its role as an invoicing currency for trade, and as a denominator of commodities.

Chandler takes his own role as a educator seriously. He rises above every temptation to retreat into jargon, and consequently provides a pleasurable read, with stimulating arguments and refreshing clarity. Over the past twelve months, many investors and savers, rich and poor alike, have felt buffeted by economic currents and financial shenanigans they barely grasped. They have lost faith in both banking institutions and policy makers. A book like this pefforms a timely function. It sheds some light at a juncture when investors most need a helping hand, and teaches intellectual responsibility for understanding how the world works.

This has to be one of the most fascinating books I have ever read. It does a good job of taking the advanced global economy and breaking it down into simple points. Chandler then goes on to point out how the accounting systems and metrics we use to value and monitor things like savings and trade are way off because the system changed since the metrics were developed before WW2.

This book takes a fresh look at the way that both investors and policy makers should look at global flows in aggregate to determine whether imbalances are forming. The historical accounting standards for global trade has been the trade account and this has been emergent because they were once the dominating flow relative to capital good flows. The strength of an economy is often looked at in terms of strength of trade position and it is argued that one needs to reflect on the health of an economy in a much deeper and more integrated manner. In particular one needs to focus on the capital flows and the ownership of the means of production on a global basis by the public to see whether there are imbalances as global supply chains by US companies have become much more important and vastly reduce the significance of measures like the trade account.

I think the perspective is a very important one. Essentially the author argues that if one compares the aggregate trade volumes of US corporates then it changes ones perspectve on the trade account because the US sales volumes and the global supply chains that create them accrue profits to US corporates that if re-patriated vs being re-invested would vastly change the perspective that the US is losing dollars abroad (as US companies are accruing foreign currencies simultaneously to dollar accumulation but they go unaccounted for). Given the global sales volumes by US companies, there can be no doubt that the trade account does not measure the aggregate change in ownership capital goods of one nation relative to another (which is what we are really trying to measure). The simplified argument goes as follows, assume there are two countries, A and B, with 2 assets for each country, a bond and a stock. B has a trading surplus with A that gets reinvested in bonds but A owns 1/2 of the businesses in B- which is better off? The author argues that A which represents the US is actually better off (not due to this example, but thats the way he sees it). But that does not follow naturally. If there is a global slowdown, B becomes the creditor and the capital gains from the debt could exceed the profits from offshore subsidiaries, foreigners could buy more US equities to embed a recursive argument into the dynamics (as foreigners would own part of the offshore/for them local branches of US subsidiaries, and thus the capital gains would accrue to themselves) etc... It could be the case that summing over the profit of foreign subs and their ownership by the american public the trade becomes balanced or even surplus, but there is no analysis done on this, it is more of an assumption.

THis book takes a fresh look at the way in which global accounting should and could be considered. But there are a LOT of conclusions to this that also need to be explored in real depth, to name a few, if capital gains need to be added to trade deficit, it brings forward the distribution of ownership and its importance. People can be mobile too, if one looks at the US market and says that US companies have a surplus account then what makes a company US? Its share registrar might be currently US residents, but if tax policies change, so could the citizens especially those with the largest capital holdings. The distribution of capital in the US will become of hightened importance, the distribution of profits to labour and capital abroad will be of hightened importance (in the US, under the presumption US companies are wholly owned by US citizens it would not be as its either dividends to labor or owners of capital), the investment preferences of foreigners toward their dollar holdings etc. I recommend reading this as it brings up a very important perspective that should be explored, but a lot more data needs to be collected to draw conclusions about where the US economy stands. At its height, consumption in the US was surely not 71% of GDP because of knowledge of foreign capital gains, it was on bad assumptions about the way their housing assets were appreciating. This brings another question to mind which is, if people are in a surplus position summing over trade and capital gains with trade being negative and capital gainst being positive in a risky environment, is that something to be satisfied with? I am not sure, clearly the risk could turn those fortunes around quite quickly (consider offshore nationalization of US companies as extreme example). The arguments presented makes one question very seriously what the dollar is worth, what it affords its holders and what drives its fundamental position in a global economy. I recommend this book as it describes new perspectives, but conclusive relative position views are not demonstrated, nor should they be, before a lot more work has been done on this approach.

(Also posted on my web site: [..])

INTRODUCTION

When I first picked up "Making Sense of the Dollar: Exposing Dangerous Myths about Trade and Foreign Exchange" by Marc Chandler, I thought it would unlock dark secrets explaining how and why the dollar has generally declined for the past ten years. I was disappointed to discover that Chandler is actually extremely bullish on the dollar despite this powerful trend. As I soaked in his contrarian optimism gushing from pages aglow with the dollar's praises, my disappointment quickly turned into morbid curiosity. In this book, Chandler delivers an interesting historical perspective, alternative and insightful approaches to analyzing currencies and trade, and eye-opening data that even a dollar bear (such as myself) must take pause to consider. While Chandler's strong pro-dollar position sometimes skews the book's reviews of trend data, in the end, I learned a lot from reading this book. I did not convert into a dollar bull, but I have adopted a bit more flexibility in my thinking. I even feel better prepared to accept a bullish dollar case whenever the trend reverses back in the dollar's favor (click here for my last technical review of the dollar index).

BOOK HIGHLIGHTS AND SUMMARY

Chandler finished his ode to the dollar in early 2009 when the dollar basked in its status as a beacon of safety. It was of course easier then to be optimistic about the dollar given the strong rebound it experienced thanks to the financial crisis. However, throughout his book, Chandler is also resolute about his optimism toward the American economy and insists America will continue to dominate the global economy.

The following quote best summarizes Chandler's faith:

"The quantitative and qualitative picture that emerges is one of a more educated American workforce that has been freed from the compulsion of physical toil, is enjoying more leisure time, and is living longer than ever before in larger and more comfortable residences."

Here are Chandler's key claims and conclusions:

1. An ownership-based framework is more important than a balance of payments (BOP) approach in analyzing trade - the ownership-based framework shows that the U.S. is globally far stronger and more competitive than many believe.
2. A weaker dollar policy is harmful to the American economy and undermines America's ability to absorb the world's excess savings. America's role as manager of the world's surplus of savings was particularly appreciated during the recent financial crisis. (Chandler does acknowledge the work of Charles Conant that describes how surplus savings can turn into an over-supply of goods, facilitated by the mechanization of production).
3. American companies have developed an expansion strategy that succeeds in strong and weak dollar markets.
4. The dollar will remain the world's most important currency for many years into the future.

Some of Chandler's specific arguments in support of the U.S. dollar are quite familiar:

* The U.S. Treasury market is the most liquid and most stable financial market in the world.
* There are no alternatives to the dollar as the world's reserve currency.
* The U.S. current account is overstated and savings are understated (Chandler proposes the ratio of net worth to disposable income as a better measure of savings - of course, this means that asset inflation [bubbles] will overstate savings)

Other arguments caught me by surprise:

* Roughly half of the U.S. trade deficit consists of intrafirm trade, the movement of goods within the same company.
* Capital flows are a much more important influence on currencies than trade. Global capital flows strongly favor the dollar.
* Build and sell locally (hub-and-spoke model) is better than an export-oriented strategy. Thus, global economic growth is much more important than global trade, and currency devaluation is not a source of economic competitiveness.

BOOK DETAILS

I will now review in more detail some of Chandler's key points and provide my own critique.

Chandler focuses on explaining how and why the U.S. economy expands and how a strong dollar supports the success of the U.S. economy. John Hay, who served as Secretary of State under presidents William McKinley and Theodore Roosevelt, provides one of Chandler's key historical reference points. Hay wrote the "Open Door Notes" which ushered in a new era of global competition when the U.S. announced it in 1900 to change the rules of engagement in China (spheres of influence). Hay argued that a country's variable share in the world economy should rely on the competitiveness of its businesses and not on the strength of its military. This approach set the stage for the American expansion strategy of producing and selling goods in home markets and importing the profits.

America's direct-investments overseas are large. In 2005, U.S. foreign affiliates sold $4.2 trillion worth of goods and services (compared to exports of $1.3T in 2005 and $2.8T in sales of 9700 foreign-owned affiliates in 2006 who employed 5.3M workers in the U.S.). All this is great news for corporate profits, but Chandler does not directly explain how all this commerce helps the average American worker.

Making goods overseas eliminates export-oriented manufacturing employment. However, Chandler notes that increasing productivity is the main driver of the decline in manufacturing employment. He provides data showing that manufacturing has continued to grow even while employment has declined. He fails to note that manufacturing growth has decelerated over the past ten years. For example, after the last recession, manufacturing did not return to 2000 levels until 2004. (Click here for data from the Bureau of Economic Analysis on manufacturing gross GDP or here for a chart from Project America.)

With America focused on producing and selling overseas, the trade deficit becomes an inaccurate measure of U.S. economic competitiveness. Chandler argues that the deficit is just an accounting entity that uses out-dated methodologies from the days manufacturing was more important to the U.S. economy. U.S. firms compete beyond comparative advantage and instead build and sell locally, reducing costs and and some of the risks of changing exchange rates.

Given these circumstances, Chandler argues that an ownership-based framework best measures economic activity. The Bureau of Economic Analysis (BEA) calculates these data on an annual basis. From the BEA:

"The ownership-based framework was developed in the early 1990s in response to interest in examining international transactions in a way that would reflect the increasing importance of multinational companies in world economies and, particularly, the growing tendency of these companies to use locally established affiliates to deliver goods and services to international markets."

The report from January, 2009 shows that U.S. exports are higher and the deficit lower than calculated with a balance of payments (BOP) approach (click here for the just released 2010 report):

"The...U.S. deficit on goods, services, and net receipts from sales by affiliates was $466.4 billion in 2007 ($2,014.0 billion minus $2,480.4 billion). This deficit was $233.9 billion less than the $700.3 billion deficit on trade in goods and services in the conventional international accounts framework. The ownership-based deficit was smaller because the receipts of income by U.S. parents from sales by their foreign affiliates exceeded the payments of income to foreign parents from sales by their U.S. affiliates.

The $466.4 billion deficit on goods, services, and net receipts from sales by affiliates in 2007 was $102.7 billion less than the deficit in 2006. This was the first decline in the deficit since 2001. The 2007 decrease resulted from a $53.0 billion decrease in the deficit on trade in goods and services and a $49.7 billion increase in the surplus of net receipts from sales by affiliates."

Note well that the U.S. still runs a deficit even by the more favorable ownership-based framework. So, Chandler continues by trying to demonstrate that the current account deficit is not correlated with the dollar. He juxtaposes a chart from the BEA on "U.S. International Transactions: First Quarter 2008 Current Account" with the trade-weight dollar index from the St. Louis Federal Reserve. The correlation does not exist over the entire time series (1973-2008); however, there is a notable and CLEAR correlation starting around 2002 as the dollar begins its steady descent along with the increase in the current account deficit. Chandler ignores this most recent trend and leaves the reader to speculate whether this change is a random outcome of data volatility, an aberration, or whether it represents some fundamental shift in economic relationships.

Regardless, Chandler also argues that capital flows matter more to the value of the dollar than trade flows. Here, Chandler lacks causal data, and instead draws examples of the relative size of capital and foreign exchange flows to trade flows to argue that "the value of the dollar is a function of all of the reasons why people want to buy and sell the dollar, whether for trade, business expansion, or investment."

Thus, according the Chandler, there are plenty of reasons to believe in the strength of the dollar since it is the world's reserve currency. Oddly enough, Chandler's reference to Triffin's dilemma seems to contradict this belief. Robert Triffin argued that a reserve currency inevitably declines and collapses because the demand for the currency encourages more supply. Increasing supply leads to larger current account deficits and then lower confidence in the reserve currency. Chandler used this theory to explain why no other nation wants to designate its currency as a reserve currency (he provided an example from Iceland's dealings with the European Central Bank). Chandler does not explain how or why the dollar is immune to this devaluation trap.

After the financial crisis abated last year, the dollar resumed the extended decline that began in 2001/2002. Bloomberg even reported on September 30, 2009 that the International Monetary Fund's (IMF's) Currency Composition of Official Foreign Exchange Reserves (COFER) data showed that the dollar's share of world reserves dropped to a ten-year low to 62.8% whereas the euro rose to a record 27.5%. (The recent decline in the euro has no doubt shifted these numbers)! Chandler uses the COFER data to claim the U.S. dollar became a larger part of global reserves from 1995-2007. He conveniently ignores that while the 2007 percentage of 64% is marginally higher than 1995's level of 59%, this share PEAKED in 2001 at 72%. I believe it is more than coincidence that this share peaked right as the dollar began its decline, but, once again, the reader is left to speculate on the structural explanations behind the data.

Similarly, Chandler overlooks the recent correlation between the dollar and commodity prices and instead chooses to aggregate a longer time series to conclude there is no relationship. He compares oil prices to the trade-weighted dollar index to prove his point. This same chart shows a direct relationship ever since the dollar's peak. The blanket claim that exchange rates cannot help predict exports, the trade balance, or stock prices ignores what many of us have at least learned in the past several years: at very important times, a direct and strong correlation can manifest itself in powerful ways. It would be more useful to explore why and how these correlations appear rather than to dismiss them by combining data across very long time periods.

Finally, there were a few sections of the book that were interesting but did not directly promote the U.S. dollar. Here is a summary of some of the more intriguing points:

1. There are multiple types of capitalism. No single type is absolutely better than the others...
* Liberal market capitalism: innovation and entrepreneurship, government mainly enforces rules of competition and provides social services)
* Corporate market capitalism: small group of companies manage entire economy
* Coordinated market capitalism: collective achievement and consensus to achieve economic efficiency and social justice
2. Government and capitalism are partners; capitalism and socialism are not polar opposites.
* In most modern capitalist countries, the majority of the economy is not profit-maximizing. For example, the U.S. government consumed 1/3 of all the country's production (before 2000?).
* The government is the lender and consumer of last resort and no one has provided a viable alternative.

Chandler also discusses the mechanics of the foreign exchange markets (for example, three trading strategies: carry trade, momentum strategy, mean reversion).

What Marc Chandler looks to do with Making Sense of the Dollar is dispute many of the commonly held views about the US currency, international trade, and related economic and political considerations. Viewing the book from the perspective of a forex trader, I found it to be a very interesting and potentially enormously useful read. In some places the author could have provided more evidence to support his assertions, and in places he gets repetitive, but the book certainly contains a lot of thought-provoking and informative material.

Chandler presents what he sees as ten myths related to the dollar and his criticisms of them. The myths he includes which most are specifically interesting in regards to gaining insight into the workings of the dollar from the perspective of a forex trader or market observer are:

1. The Trade Deficit Reflects US Competitiveness
2. The Current Account Deficit Drives the Dollar
6. The Dollar's Privileged Place in the World is Lost
9. The Weak US Dollar Boost Exports and Drives Stock Markets

This isn't to say the others aren't worth reading. It's just that these four most directly get to the major issues a lot of market watchers cite as to why the dollar has lost or can be expected to lose its high standing.

The trade and current account deficits are things many folks, professional and otherwise, point to as unsustainable issues which eventually will have to correct - to the detriment of the dollar. Chandler says both are flawed measures based on outdated methodologies which do not properly account for modern trade and capital flow. That's the focus of Myths 1 and 2.
In regards to Myth 6 about the dollar losing its stature, the author brings up a number of defenses for the greenback. One of them is the view that I myself have expressed on several occasions that one of the reasons that the dollar is the top reserve currency is the breadth and depth of the US financial markets. No other country or region can come close to matching them, making the US the place where excess savings looking for a safe place to sit comes, as witnessed by the dollar's gains during risk aversion. This is why the greenback has not actually lost ground to in terms of the total % of global reserves.

Regarding the idea that lowering the dollar's exchange rate will boost exports and reduce imports (Myth 9), Chandler indicates that there's no real evidence to support that notion. For example, he notes that in the early 90s a pair of Congressmen suggested the dollar was 20% overvalued and needed to come down to close the trade gap. The dollar trended down for most of the decade, losing about 20% of its value in that span, but the trade deficit actually expanded. The author also points out that much of the cost of import goods to US citizens is actually added on to them once they reach our shores, so that the value of the dollar isn't really a major influence on the prices we see. And of course he also points out that the largest portion of our imports comes in the form of oil and related products, the demand for which is relatively inelastic over the short- to intermediate-term.

New forex traders can often be heard to ask questions about what fundamental factors drive exchange rates, and with good reason. It can be a very confusing market in that regard as things which are clear drivers in one direction at one point in time can be drivers in the other direction later. Chandler does a really good job in the space of a couple of pages in the 10th myth chapter of addressing the primary factors impacting the forex market and the concept of currency valuation. That's really the only place "trading" of currencies is discussed. The rest of the book is more focused on looking at the big macro dollar picture.

As much as Chandler makes some interesting points about Capitalism vs. Socialism, in my view he spends too much time on the subject (Myths 5 & 8). One could even ask whether he needed to address it at all, but I was fine with it. He just got a bit repetitive on the subject.

The bottom line as far as Chandler is concerned is that the dollar is just fine the way it is and that attempts to focus on imports and exports and weaken the dollar to influence them could produce serious negative consequences. I definitely recommend Making Sense of the Dollar to anyone interested in the macro view of the dollar and global currency markets.

Many people think in non-systematic terms. They consider the US current account deficit to be an unmitigated disaster. They look at one side of the issue and conclude that the US has become less competitive.

Understanding accounting, the books must balance. Not everyone can run a current account surplus. Some countries must run deficits in order to purchase goods from those that run surpluses. Capital account surpluses balance out current account deficits; net foreign investment fills the gap.

Marc Chandler, with whom I became acquainted while writing for RealMoney, has written a book for the average reader to explain the basics of international economics and foreign exchange. The book deals with common myths that arise in the discussion of trade and currencies.

Why do we lose industrial jobs in the US? It's not foreign competition, though that may occasionally play a role when countries subsidize their industries. We lose industrial jobs because of technological improvements that require less labor in the manufacturing processes. As I have said, Nucor was a bigger risk to the rest of the steel industry than foreign competitors.

Chandler is a proponent of the turn-of-the-century Open Door Policy, which led the US to be more free market capitalist than the rest of the world, gaining influence through trade. Together with military victories, this led the US to be the world's dominant economic power post-WWII. Given the change in currency regimes, this made the US Dollar the leading reserve currency in the world.

Aside from military superiority, and political calm, labor market flexibility and a culture of innovation have made the US dominant in global economic affairs. As I have sometimes said, if the world did not have America, it would have to invest one. Where else would all of the spare labor, capital and goods go?

There are advantages to being the world's reserve currency. The US runs current account deficits, and other nations buy our debts. Such a deal; every nation should want this (but, as we learn, it is likely only one nation can have this at a time).

Capital flows are much larger than trade flows; it should be no surprise that the US Dollar does not react to the current account deficit.

(An aside: when I was in Grad School, the idea that interest rates drove currencies through arbitrage was new, and gaining favor. Since then, a blend of the interest rate markets and goods markets driving currencies is the dominant paradigm, with momentum thrown in.)

Chandler deals with these issues, and other myths that plague the discussions around international economics and the currency markets. In general, I agree with his views, but with a few quibbles/additions:

* It is not costless for countries to run current account deficits. Countries that run current account deficits have to offer attractive opportunities for foreigners to invest in their country, or suffer declines in the value of the currency.
* The country taking the non-economic action will eventually pay the price. Whether hoarding gold in mercantilism, or neo-mercantilism, hoarding US debt assets, whether Japan in the late '80s or China today, the nation forcing the issue gets hurt more. China will suffer for over-promoting growth of exports.
* It would be reasonable to have a gold standard once more -- the trick is setting the initial price level, so that it would not be inflationary or deflationary.
* It would have been nice to offer retail investors some theory to explain how currencies move, rather than just dispel myths. That said, there probably is no such theory, and if it exists, ordinary people probably could not understand it.

Absent my quibbles, on foreign currency Marc Chandler knows far more than me. If foreign exchange and trade is of interest to you, you will benefit from this book. One more note: this is not a technical book with lots of math, and there is no technical analysis on its pages.

In "Making Sense of the Dollar", Marc debunks text book economic theories that are a century old and gives a more practical understanding of the misconceptions that surround the dollar. Whenever the U.S dollar drops in value, the media and analysts pounce on it with similar distortions. On the contrary, Marc always provides a unique counter perspective; an approach that can also be found in his book.

Example: Marc deciphers the trade deficit argument and points out the reason why the United States has been running deficits, why the argument that "exports are good, imports are bad" does not apply to the U.S, and how U.S companies contribute to the trade balance.

The book is full of interesting facts and figures. Marc provides evidence for his arguments and discusses various issues such as manufacturing, demographics and much more. This book is a must read for policy makers, students and investors as it will help explain the dynamics of the U.S economy through an optimistic view with hard evidence.

Marc Chandler is one of the most widely respected, prolific pundits on currency markets and foreign exchange. In this book for lay readers, he summarizes "dangerous myths" about currency markets and foreign exchange. The myths are dangerous because they can lead to the kinds of mistakes in public opinion that generate disastrous political and economic policymaking. getAbstract recommends this accessible book and finds that Chandler does an excellent job of summarizing and countering some of the most wrongheaded, naïve or confusing blunders, blinders and bewilderments that vex discourse about the dollar, the trade deficit and the economic strengths of nations.

An interesting book, although I could dispute some claims the author makes.

I read the book as a Forex trader in the hope of gaining useful information. I didn't. There is only one thing that moves the market beyond market noise, and that is a strong indication that money will pour into or out of a particular country. That is the foreign exchange environment in a nutshell, and everything else is just another "dangerous myth."

More useful for traders who want to take the long view is, perhaps, Europe's Promise by Steven Hill. It will at least provide some facts to ponder when analyzing which economy is likely to attract money in the long run.

Another great book about international trade and international finance. These days, everyone from politicians to CNBC analysts and commentators have an opinion about current international economics and the future of the American economy. Mr. Chandler provides a wonderful commentary about how the international financial system works and why many doomsayers are wrong about their predictions.

This book also has an excellent chapter that describes the differences between capitalism and economic systems in America, Europe, and Asia. He also discusses how culture and social institutions influence how these economies are managed and why governments make certain policy choices.

As someone who lives in Asia, I have been surprised to see the differences in policy, economic systems and banking systems as a result of culture and social stability. All of these differences were brilliantly pointed out by Mr. Chandler.