The third-quarter earnings season has been delivering much better-than-expected gains, with 82% of reporting S&P 500 companies beating analyst earnings estimates and 61% beating sales estimates. Most reporting companies have also issued positive sales and earnings guidance for the current quarter. But, believe it or not, the stock market seems to be influenced more by the daily gyrations of the weak dollar than by new earnings announcements.

Treasury Secretary Rallies the Dollar . . . for a Day

Specifically, the market panicked on Tuesday, after U.S. Treasury Secretary Tim Geithner talked up the dollar. Then, the market recovered when the dollar resumed falling.

On Tuesday, the Chinese yuan and U.S. dollar rallied briefly after the People’s Bank of China raised its benchmark deposit and lending rate by 0.25%, its first interest rate increase in three years. On the same day, Geithner denied that the U.S. was deliberately weakening the U.S. dollar, saying that no nation can “devalue its way to prosperity.” Geithner was apparently reacting to charges of a “currency war” made by Brazil’s Finance Minister, Guido Mantega, who had raised the tax on fixed-income investors from 2% to 4% and declared that foreign capital would be taxed at a lofty 6%.

It is obvious to most of the world that China and the U.S. are at least “pretending” that they are not weakening their currencies for short-term trade advantages. There is clearly a lot of tension heading into the upcoming G20 meeting in Seoul, South Korea in early November. In advance of that meeting, the G20 finance ministers met last weekend to plan the agenda for the Korean meeting. Going into the weekend meetings, Secretary Geithner said that his goals were (1) to advance efforts to “rebalance” the world economy so that it is less reliant on U.S. consumers, (2) to move toward establishing norms on exchange-rate policy and (3) to persuade others the U.S. does not aim to devalue its way to prosperity.

However, it appears that the real objective of U.S. monetary policy is to try to get 19 of the G20 countries to “gang up” on China, which currently holds $2.5 trillion in foreign currencies, of which $1.5 trillion is in U.S. dollars. In a thinly-veiled criticism of China, Geithner said that “emerging market countries with significantly undervalued currencies and adequate precautionary reserves need to allow their exchange rates to adjust fully over time to levels consistent with economic fundamentals.” In the end, however, it doesn’t matter much what Geithner wants. China has the financial reserves to play a strong hand.

Geithner’s stand did not have staying power: The strong U.S. dollar lasted only one day, Tuesday, when the S&P 500 fell 1.6%. By Wednesday, the U.S. dollar resumed its slippery slope and the stock market rallied. Wall Street investors know that a weaker dollar magnifies corporate profits for multinational companies. The U.S. dollar may rally on any given day, but it will remain weak as long as short-term interest rates are low, public debt is high and growing, and U.S. economic growth remains weak.

The worldwide perception is that the U.S. is fiscally irresponsible, although that perception may shift after next week’s elections. For now, even the relatively-weak euro looks strong compared to the dollar. Since June, the euro has recovered from $1.19 to $1.40, in part because of Europe’s attempted austerity cuts…

Europe’s Austerity Cuts Cause Economy-Choking Protests

Speaking of austerity cuts in Europe, the protests in France over raising the retirement age to 62 from 60 disrupted airline and rail service, as well as many other businesses. After refinery workers cut off the fuel pipelines to the Paris airport, numerous flights were canceled and many filling stations ran dry. The French government responded by tapping its strategic oil reserves, which hold only three months’ supply. Despite France’s traditional tolerance for strikes and protests, public patience is starting to wane after several weeks of stop-and-go traffic, cancelled flights, scarce gasoline supplies and rising urban violence.

In Britain, Chancellor of the Exchequer George Osborne shocked Parliament by proposing massive public spending cuts of $131.9 billion over the next four years – cuts that reached 25% for some agencies. (The BBC’s budget, for instance, will be cut by 16%.) Osborne’s “Spending Review” was greeted by a chorus of boos in the House of Commons. According to Britain’s Office of Budgetary Responsibility, up to 500,000 public sector jobs could be cut by 2015. Osborne is also expected to announce further cuts to welfare benefits. His ambitious goal is to eliminate all of Great Britain’s structural budget deficit by 2015.

The International Monetary Fund has praised Britain’s new government commitment to tackling its structural deficit, which is currently similar to the U.S. as a percentage of GDP. In a sense, these British actions could be a “preview of coming attractions” if cost-cutters dominate the U.S. Congress next year.

As the November mid-term elections near, it will be interesting to see if the new leadership in Congress will push for similar budget cuts in 2011. Although the British and U.S. debts (as a percent of GDP) are equally high now, I must add one significant difference: Britain’s government debt sports an average maturity of 12.7 years, while approximately 90% of the U.S. debt is financed in Treasury bills and notes with an average maturity under two years, at very low interest rates. This puts a special burden on Britain to act now, but if rates or maturities rise in the U.S., we could face a similar dilemma next year. Until the U.S. faces its long-term structural debt problems, the U.S. dollar will continue to decay.

That, in turn, will boost U.S. corporate profits and help stimulate U.S. exports, so the stock market continues to celebrate.