Budget deficit

We can repeat the exercise and analyze the dollar in terms of the federal budget deficit as a percentage of GDP. The idea here is that an increasing percentage of each additional dollar the federal government borrows must come from foreign investors. As American dependence on foreign borrowing increases, so too does the potential for moral hazard: We can drive the value of the dollar down and repay our creditors in increasingly worthless currency.

For a relationship to be causal, it must work at all times and in all market conditions. However, it shows the deepening of the federal deficit in the late 70s and early 80s both led and coincided with the surge in the DXY. The deficit’s small retreat in the late 80s both led and coincided with dollar weakness. Finally, the narrowing of the federal deficit and its move toward a surplus during the 90s led an eventual move higher in the dollar by too long of a period — more than three years — to be causal.