One of the big themes over the past year has been the strength of the US Dollar, which has appreciated against currencies and commodities since the middle of last year. That pushed many currencies into “undervalued” territory – exchange rate levels that are below what is suggested by their economic fundamentals. That’s certainly the case here in Malaysia, oil price declining notwithstanding.
But given that its been largely a move by the USD, it would be fair to flip the question on its head: If other currencies are “undervalued”, the opposite must also be true. How “overvalued” is the USD?
So for your weekend amusement, I present a quick and dirty approach to doing just that (index numbers; 1990-2015):
The two indexes above are the USD nominal and real broad effective exchange rate indexes, from 1990 to the present. In theory, if the Dollar was correctly valued, both indexes would be quite close to each other.
Instead, what we have is a convergence up to about 1994, and then an increasing divergence up to about the time of the Asian Financial Crisis. Thereafter, the deviation between the indexes has been approximately steady, until a creeping divergence set in after the GFC (log difference between indexes):
From about 12% overvalued in 2008, the USD exchange rate has progressively gotten overvalued until the difference reached 20% at the end of the plot (the data I have above goes to Mar-15).
We’re talking here about a period of fundamental deviation in the nominal value of the USD away from its real value, that goes back over twenty years. Explaining this would take some doing, which I won’t even attempt here.
Nominal and Real Broad Effective Exchange Rate Indexes from the Federal Reserve Board