from Follow the Money

Stephen Jen might want to rejigger his model

January 30, 2005

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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Apparently, Mr. Jen thinks the dollar -- despite the United States’ 6.2% of GDP current account deficit -- is significantly undervalued against all major currencies, and fairly valued against most Asian currencies.

Call me old-fashioned, but in my book, a large current account deficit is a sign that a country’s currency is overvalued, not undervalued. Another sign of overvaluation: heavy central bank intervention to support the currency. The US just happens to have outsourced currency intervention to a group of largely Asian central banks, who spent close to $200 billion in the fourth quarter to keep the dollar from falling against their currencies.

However, Jen argues that the dollar today is like the dollar after in 1988, after the Louvre agreement (Plaza = G-7 signal the dollar had to fall, Louvre = G-7 signal the dollar had fallen far enough), of the dollar in 1995, after it has slumped v. the yen. It is poised for a large rally.

Hey, why worry if a dollar rally would push the US current account deficit toward 7% of even 8% of GDP -- or somewhere between 70 and 80% of US export revenues?

I recommend that Mr. Jen add the current account deficit to his model of fair currency valuation. Adding the current account deficit would highlight the difference between 2005 and 1995, and 2005 and 1998. In 1988, the current account deficit was 2.3% of US GDP, down from 3.4% in 87 and on track to fall toward 1.4% in 1990. In 1995, the US current account deficit was only 1.5% of GDP. The US net external debt position was a lot better back in 1988 and 1995 than it is now too ...

Of course, Morgan Stanley has Stephen Roach as as well Stephen Jen. And a market requires buyers as well as sellers. But I do wonder if Morgan Stanley is willing to put its money behind Mr. Jen’s model. After all, doesn’t the model say the dollar is 20% overvalued v. the euro, and should trade at 1.09?

One caveat. While I -- like Bill Gates (thanks Jesse) -- think the dollar is overvalued today on a broad trade-weighted basis and a further fall in the dollar is likely, that does not necessarily mean that the dollar is overvalued v. all other currencies. Clearly the dollar already has fallen by much more against the euro than against the renminbi. Still, how can Jen discuss the fair valuation of the dollar without at least mentioning the current account deficit? I will be travelling for the next few days, so do not expect any more posts before Tuesday.

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