In his book Changing Fortunes, former Federal Reserve Chairman Paul Volcker wrote that the most important price to a nation is the price of that nation's currency in foreign exchange markets.
In 2017, I believe that we will see just how important the value of the dollar is to the U.S. and the world.
The U.S. dollar is the world's go-to currency when in comes to safety, and as a store of value.
It has proven this over the past eight years or so as the world, and especially Europe, has endured several periods of financial turmoil. One reason for the negative yields on many maturities of TIPs (Treasury Inflation Protected securities) is that the United States is a "safe haven" for many investors seeking to protect their funds.
Although the United States economy is not that strong, it has been stronger than most other major economies. Consequently, the monetary authorities in the United States have been debating whether or not they should raise the central bank's policy rate of interest, while the monetary authorities in other parts of the world are keeping monetary policy loose and considering whether or not they should seek lower interest rates.
This situation will not end soon.
It now takes less than $1.04 to acquire one Euro. In early 2014, one Euro cost close to $1.40. The value of the dollar has risen by almost 35%.
The Fed's trade weighted U.S. Dollar Index against major currencies stood around 76 in early 2014. Now the index is over 96. The value of the dollar has risen by 26%.
The value of the U.S. dollar will continue to strengthen in 2017. That's primarily because the United States dollar will continue to serve as a safe haven for world monies.
This comes amidst uncertain global conditions.
In the European Union, Greece is on the edge of another financial crisis; Italy is facing a political storm and struggling economy; France is having an election in the Spring, and there are many pundits arguing that Marine Le Pen and the right wing National Front may stage a Donald Trump-style win; and even the German elections, which take place later in the year, are uncertain.
In addition, the European Union still must struggle with the after affects of Brexit.
There's ongoing turmoil in the Middle East, a volatile situation between the Ukraine and Russia, uncertainty in China and restlessness in many emerging markets.If anything, financial analysts are saying that market volatility will not only remain in 2017, but in all likelihood, will increase. Safe havens are good.
The dollar will continue to strengthen in no small part because the United States will continue to outpace much of the rest of the world in economic growth in 2017, regardless of what the new Trump administration attempts to do in the early part of the year. The policy efforts of the new administration will generate some optimism, even if they take time to impact the economy.
Furthermore, the Federal Reserve has given us "new" forward guidance: It is expecting to raise it's policy rate three times in 2017, by 25 basis points each time. For some reason, this "guidance" seems more credible now than it did one year ago. Anyhow, barring the unforeseen, there should be two rate increases in 2017.
The difficult thing about this scenario is a possible conflict between the imagined economic policies of the Trump administration and the pressures that the Federal Reserve will face.
The Trump administration wants to protect American industries and keep businesses in the United States. It is threatening trade barriers and other such factors that will shelter U.S. corporations. This will work to reduce imports.
But the strong U.S. dollar will hurt American exports, slowing economic growth and limiting markets for U.S. corporations.
How this conflict will be handled will be important for the future of the United States. If policymakers look at these issues as a concern about aggregate demand, we will all lose.
If policymakers consider these issues as a call for economic restructuring, to make transportation more efficient, to allow for the further spread of information, to raise labor productivity and to use capital more effectively, then the U.S. will become more competitive -- capable of maintaining the world's strongest currency, including strong exports.
The value of the dollar in world markets will become a greater issue in 2017 because the United States dollar will continue to increase in value. The dollar will break the "unity" barrier with the Euro, and the cost of one Euro will approach $0.95 during the year.
Expect also the Fed's Trade Weighted U.S. Dollar index against major currencies to break through 100 and even pose some threat to 105.
If Europe breaks apart, or, there is outright war in the Middle East, or further conflict occurs with Russia, or China becomes more aggressive, the dollar could become even stronger.