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Dollar update: still weak, but improving

The Fed's calculation of the inflation-adjusted value of the dollar against both major currencies and a very large basket of currencies shows the dollar has improved on the margin over the past two years, but it is still fairly close to its all-time lows. This is a reminder that optimism about the prospects for the U.S. economy, at least insofar as it is reflected in the world's desire to own dollars, is in relatively short supply. The outlook is not good, but at least it is improving on the margin (i.e., things are getting less bad).

One helpful development is the recent weakness in the yen, propelled today by the Bank of Japan's strenuous efforts to weaken the currency in order to reduce and perhaps eliminate the deflationary pressures that have plagued the economy for decades. As the chart above shows, the yen rose significantly (even awesomely) beginning in 1985. It reached a peak about a year ago, by which time its had more than tripled in value vis a vis the dollar (put another way, the dollar lost about 80% of its value vis a vis the yen).

As I've noted before, the yen's recent weakness has been a source of great cheer for the Japanese stock market. This is not the result of Japan engaging in "competitive devaluation." Rather, it is a case of Japan attempting to reverse the crippling, relentless revaluation of the yen that has made life miserable for the country's exporters for decades.

UPDATE: The Nikkei is up almost 4% in Friday trading, and the yen has fallen to 97. This is the hottest trade on the planet right now: long Nikkei/short yen.

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