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The writer is professor of economics and political science at the University of California, Berkeley
Dollar doom and gloom is in fashion. The broad dollar index is down about 10 per cent from mid-March. Most banks and forecasters expect the trend to continue, with some predicting that the greenback could fall 20 per cent or more in 2021.
Were this a surety, it would have happened already, of course. And we know that it’s precisely when all the smart money is on one side of the market that there’s the greatest risk of prices moving in the opposite direction.
Four arguments are made for why the dollar is poised to fall. First, as a safe-haven currency, the dollar strengthens when uncertainty spikes, as it did in March. Now, with the rollout of vaccines, the worst Covid-related uncertainty is behind us.
However, this vaccine-related news is already in the market. There may be some residual uncertainty about the manufacture, distribution and take-up of vaccines, but surely not enough to justify a further 20 per cent fall in the dollar.
Second, there is continued easing by the US Federal Reserve, which has been more aggressive than other central banks in the expansion of its balance sheet. Those other central banks are not done, however. The ECB in particular seems reluctant to accept additional euro strength and has signalled it will act to limit currency appreciation.
Third, there are America’s twin budget and current account deficits. These must be financed by importing capital from abroad. Attracting that foreign finance requires making US assets more attractive by cheapening the dollar.
This, of course, is the same “twin deficits” hypothesis widely invoked before the financial crisis by those predicting a dollar crash. The dollar didn’t crash then, and there’s good reason to doubt it will crash now.
To be sure, the US government will probably continue running budget deficits as far as the eye can see. With the public sector saving less, the US current account, which is the difference between investment and saving, will then move deep into deficit, other things equal.
The problem being, precisely, that other things are not equal. US public saving may have fallen but private saving has risen. Part of this increase is a temporary lockdown effect: it’s hard to spend on holidays and dining out while quarantined. But another part is likely to persist. American households have been reminded of the inadequacy of their precautionary saving. Not being able to pay the rent after only four weeks out of work is a wake-up call.
We know this from history. US savings rates went up and stayed up as a result of the Depression. Individuals who experienced that searing episode at first hand remained more financially and economically conservative for the balance of their lives. Covid-19 now may well have an analogous effect.
Nor will investment be unaffected. Big investment projects will remain on hold until companies have a clearer sense of the shape of the post-pandemic landscape. Will they be prepared to invest in inner-city office space, business hotels or large airliners before they know how much of the shift to remote work is permanent? Even if US saving rates remain low, investment may be low as well over the several-year horizon relevant for currency forecasting.
Currency markets evidently haven’t taken these points on board but other market participants clearly have. If a persistent fall in domestic savings and the early recovery of investment were on the cards, then we would observe sharp increases in interest rates and inflation rates implied by US Treasury bond trading. However, there have been only very modest movements in that direction.
Fourth and finally, it is argued that the end of US geopolitical dominance inevitably presages the dollar’s fall. America’s global hegemony since the second world war was an important foundation of the dollar’s status as the leading global currency. That dominant position has now been diminished by President Donald Trump’s erratic unilateralism. Other countries view the US as a damaged democracy and an unreliable alliance partner. China and the renminbi, for their part, are well positioned as alternatives.
While there is something to that point, incoming president Joe Biden can undo some of this damage by recommitting to multilateralism and its alliance partners. Moreover, China and the renminbi have a long way to go to reassure foreign investors. Seizing the bank accounts of political dissidents, as Hong Kong’s government recently did, will certainly not encourage faster take-up of the renminbi.
Forecasting exchange rates may be a fool’s game, but for all these reasons it would be foolish to bet on the dollar’s continued decline.
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