economics
Is the Dollar’s Status in Jeopardy?
Economics, Yale University
President, Rosenberg Research
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Genesis
Response
Penultimate
Finale
June 24th, 2020
While a sharp decline of the US dollar would come as a surprise to most, it is not an uncommon development. Against a basket of America's major trading partners, the dollar's real effective exchange rate (REER) has experienced three major corrections in the past 45-50 years — a 33% drop from 1970 to 1978, another 33% correction between 1985 and 1988, and a 28% decline from 2002 to 2011 (by BIS statistics).
Long viewed as the linchpin of the global financial system, the dollar has taken on teflon-like status in times of crisis. That is certainly where the COVID-infected world finds itself is at this point in time. But as this crisis unwinds, as they all invariably do, the dollar is likely to be adversely affected by the confluence of three powerful headwinds:
1. An unprecedented plunge in domestic US saving is at hand. Pre-COVID, net domestic saving (depreciation-adjusted saving of businesses, consumers, and the government sector) was just 1.4% of national income in early 2020; courtesy of an exploding federal budget deficits — averaging at least 14% of GDP over 2020-21 (as per the Congressional Budget Office) — this key gauge of saving could plunge into the -5% to -10% range, pushing the current account deficit beyond the previous -6.3% record. Foreign asset allocators are likely to demand concessions to provide the capital. With inflation low and the Federal Reserve committed to maintaining an easier monetary policy stance for an unusually long period, the bulk of the current account adjustment will be forced through the exchange rate rather than through interest rates.
2. America's global leadership position has been tarnished beyond recognition. From leading the charge in deglobalization and decoupling to drawing serious questions about its once unfailing support of the architectural pillars of the world order — WTO, WHO, the Paris Climate Agreement, and the now defunct Trans Pacific Partnership — to failing abysmally at COVID containment, to plunging into the chaos of racial dysfunction, the United States is far from the shining beacon on a hill that allowed the dollar to reign supreme for so long.
3. The dollar is no longer the only the game in town. In 2000, the dollar accounted for a little over 70% of world foreign exchange reserves; today, that share is less than 60%. That makes it far easier for other currencies to fill the void. The euro is a leading candidate, in my view. Led by Angela Merkel of Germany and Emmanuel Macron of France, the newly established €750 Next Generation EU Fund, along with the backing of a pan-European bond facility, could well provide a surprising boost to the most unloved major currency in the world. Similarly, as China continues down the road of reform and opening up its financial system, the Renminbi should resume its upward ascent. Cryptocurrencies and gold should also benefit.
COVID time runs at warp speed. A 35% decline in the broad dollar (REER) index is likely to come sooner rather than later.
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