American Consequences - September 2020

Is The Almighty Dollar Sinking?

Moreover, some developed countries (in Europe and elsewhere) and some emerging markets (such as China and others in Asia) are doing a much better job of containing COVID-19 than the United States is, implying that their economic recoveries may prove to be more resilient. The public-health failures and related economic vulnerabilities in the U.S. are thus further contributing to the dollar’s weakness. The dollar will continue to benefit from a broad- based system of flexible exchange rates, limited capital controls, and deep, liquid bond markets It also bears repeating that before the pandemic, the dollar had appreciated by over 30% in nominal and real (inflation-adjusted) terms since 2011. Given the yawning U.S. external deficit, and because interest rates are not high enough to finance it with capital inflows, a dollar depreciation was necessary to restore U.S. trade competitiveness. And the U.S. turn to protectionism signals that it prefers a weaker dollar to restore external competitiveness. Even in the short run, the dollar could strengthen again if – as the latest global growth data suggest – a V-shaped recovery stalls into an anemic U-shaped recovery... let alone a double dip, if the first pandemic wave is not controlled and a second wave kills the recovery before effective vaccines are found. In the medium to long term, multiple factors could preserve the greenback’s global

dominance. The dollar will continue to benefit from a broad-based system of flexible exchange rates, limited capital controls, and deep, liquid bond markets. More to the point, there simply is no clear alternative currency that could serve as a broad unit of account, means of payment, and stable store of value. Furthermore, despite its pandemic travails, the potential annual U.S. growth rate, at around 2%, is higher than in most other advanced economies where it is closer to 1%. The U.S. economy also remains dynamic and competitive in many leading industries, such as technology, biotech, pharmaceuticals, health care, and advanced financial services, all of which will continue to attract capital inflows from abroad. Any country vying for the U.S. position would have to ask itself if it really wants to end up with a strong currency and the associated large current-account deficits that come with meeting the global demand for safe assets (government bonds). This scenario seems rather unattractive for Europe, Japan, or China, where strong exports are central to economic growth. Under the current circumstances, the U.S. is likely to maintain its “exorbitant privilege” as the issuer of safe long-term debt that private and public investors want in their portfolios. The question, then, is what factors might undermine the dollar’s global position over time. First, if the U.S. keeps monetizing large budget deficits, thereby fueling large external deficits, a surge of inflation eventually could debase the dollar and weaken its attractiveness


September 2020

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