For the dollar to strengthen takes the world economy into truly unknown waters.
Brad Setser writes:
http://www.rgemonitor.com/blog/setser/151516: The FX market doesn't think the US should adjust ... at least not right now. The dollar has been rather strong relative to the yen for some time now. And it is currently getting even stronger.
The dollar was weak against the euro at 1.28 – and at say 1.25, it is still pretty weak. Ask Airbus, which sells planes for dollars and buys parts in euros. But right now the dollar is also rallying against the euro.
And my friends at Danske “Geyser Crisis” Bank think the dollar could reach 1.16 or so. Ok, 1.16 is just their headline -- but they are looking for 1.20. Danske doesn’t think that the US is the Iceland of the G-3.
If the dollar continues to rally against the other major currencies even as the US economy slumps, well, that will have consequences.
For one, don’t look to exports to help the US get out of a slump. And don’t look for the US slump to bring about a big improvement in the US balance of payments.
Getting a big improvement in the current account deficit is hard, given that the US imports a lot more than it exports and net interest payments are set to rise sharply. So, setting a big swing in oil prices aside, the scenario where the US trade deficit falls is one where US import growth slows and US export growth stays strong. Not one where both import and export growth slows.
And for that matter, if China's exports continue to grow at a 30% y/y pace -- faster than they were growing earlier this year -- it isn't obvious to me that US import growth is slowing. At least not yet. Asian electronics exports seem to be picking up, and presumably not all those exports are going to Europe.