The U.S. Dollar Vs. International Equities

The 2nd chart Trade Weighted USD Major Currency Index vs. WTI Crude Price is from Jan 1973 to Present. One can see the inverse relationship to WTI and the long term ~0.8% decline trend in Trade Weighted USD Index Major Currencies. It is what is behind the long term trend that forms the expectation that Trade Weighted USD Index Major Currency should return to trend in the next few years. The basis for the declining USD against global currencies is in the story of global trade. Countries with the highest productivity and creativity in advancing global standards of living have the most active trade relationships. In seeking the lowest-cost standard-of-living improvements individuals direct their income transaction-by-transaction to those products and services which carry the greatest value for their income. Services are always local. Products however can be manufactured anywhere and imported if they provide value. Simply being cheaply manufactured does not fulfill the desire for improvements in standard of living for the consumer. The overall good must provide a combination of attributes that includes cost, functionality, appearance and etc. which only individual buyers can judge correctly for themselves. It is in manufacturing in other countries to provide goods which are competitive against other choices consumers have available that global trade plays its part.

Advances in Standard of Living = Intellectual Creativity = Net Profit Margins = Wealth Creation

In Free Market global trade, it is individuals in each country who make choices to benefit their own standard of living. The individuals in the country which creates the greatest standard of living advances also creates the largest wealth. Wealth is directly correlated to the intellectual value added to the individual standard of living, which is in turn correlated to Net Profit Margins of corporations who do this better than other corporations. It is Net Profit Margins and the competition to provide value to individual consumers, which make Free Markets so effective at standard of living advances. Governments that claim to do this via command economies have always failed. Venezuela’s mass deprivation is a good recent example of failed Socialism.

To understand this one only has to look at the difference between the Net Profit Margins of Microsoft (NASDAQ:MSFT) and Apple (NASDAQ:AAPL), 40%+ and 25%+ respectively, against supermarkets and superstores which only distribute goods made by others and have Net Profit Margins of 1%-2% and 2%-3% respectively. Microsoft and Apple provide products which greatly reduce the cost of communication, analysis and transfer of intellectual information in society. The intellectual value of this benefit is reflected in wide Net Profit Margins. It is in the millions of daily individual choices transaction-by-transaction which sets Net Profit Margins for corporations. If the value is not present, individuals will spend their income elsewhere.

Microsoft creates and duplicates its products in the US. The labor costs for duplicating software are non-existent and Microsoft does this in the US and has 40%+ Net Income Margins. Apple in comparison provides software on a hardware platform. It is the hardware which is complex and requires labor cost to manufacture. Apple outsources manufacturing to the lowest cost providers which means it must give up some of its profit margin to someone else. Apple’s Net Profit Margins are 25%+. Apple and all computer manufacturers have outsourced manufacturing and assembly to lower cost countries from the very early years. They have shifted sites as wages have risen in foreign countries. When Apple, the intellectual value creator, manufactures in lower cost countries and imports back to the US the USD falls in relation to the currency of that country in which manufacturing occurs.

Multiply the Apple impact across all those companies in the US which have created intellectual value for society and used lower cost manufacturing countries, it should be clear that the net effect is to cause the currency of the country with the greatest value creation to fall in relation to others with which it trades. Note: Wages have always risen in those countries US companies to which exported manufacturing. Through our own desire to get the best value for our individual income, we raise the income of others and improve the standard of living of others. Through global trade, the most intellectually creative country raises the global standard of living. This is a natural process of Free Markets.

Global trade dominates the Trade Weighted USD Index Major Currency trend. While global trade is far more powerful than short term swings in market psychology, the impact operates over a longer term and much more slowly. Nothing has changed the last several years to upset this long term trend. I expect the Trade Weighted USD Index Major Currency to return to trend and commodity and Intl Equities to respond as they have historically.

Written By: Todd Sullivan