Anthony Rowley: Why the U.S. dollar slide may be a sign of real danger this time


By Anthony Rowley
South China Morning Post, Hong Kong
Monday, August 3, 2020

The unnatural calm that settled over financial markets in the wake in the Covid-19 pandemic is being disturbed by ominous signs that the US dollar is in trouble. This is not just a matter of risk-off moments or yield differentials, as some suggest. Something more fundamental is at work.

What makes the behaviour of the dollar particularly ominous is that the world's key currency is sliding not only against benchmarks such as gold and silver but also against many measures of value including other key currencies. A general depreciation of the world's leading currency is rare.

The dollar is at a two-year low against a basket of currencies and US Federal Reserve chairman Jerome Powell's statement on July 29 that the Fed will keep monetary policy very loose, at least until the end of this year, portends further weakness.

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Even if the main reserve and transaction currency is not exactly tottering, its wobbles hint at scenarios where it has to share pole position with other currencies, an unstable state in itself.

Conventional wisdom holds that the dollar will retain pole position as the paramount global currency because the euro is not in a position to offer a real challenge and China is cautious about dismantling yuan exchange controls, while the Japanese yen is not a serious contender.

Recent events suggest, however, that the dollar could erode from within as the US retreats increasingly from international obligations and as its domestic economy weakens. In that case, some of the many exporters dependent on China could be persuaded to accept more yuan transactions.

Dollar depreciation could, as some suggest, simply reflect the fact that financial managers everywhere are "rotating" out of the US currency in search of yield as real or inflation-adjusted returns on dollar securities hit zero or even negative levels.

This is obviously a factor but there is certainly more to the dollar's decline than just yield. As suggested here before, confidence in currencies and faith in them as measures of value and as mediums of exchange cannot survive the idea that their supply is virtually endless.

This could sink financial markets and undermine the global economy as financial markets continue to skate blithely but precariously on the thin ice of dollar-based support, whether in the form of government bond buying, bailout loans, currency swaps or other liquidity injections.

Unconventional monetary policy has tested credibility among those who feel uneasy about the availability of so many "free lunches." First, interest rates fell to historic lows or even zero, central banks vacuumed up securities from the market and then governments began giving away money.

The motive behind all these moves is the need to maintain aggregate demand, prop up asset values and avert a financial system crisis. But as Hung Tran, at the Atlantic Council in Washington says, central banks risk creating moral hazard by acting as overzealous lenders of last resort.

This "trap," as he notes in a recent paper, "occurs when market participants perceive little-to-no consequences for potentially excessive risk taking, as they come to believe that they will be protected should things go awry."

Post-Covid-19 action by central banks stabilised markets, setting the stage for economic recovery. But coming on the heels of huge monetary easing
during the last global financial crisis, it has "reinforced the market's belief that [central banks] will [always] take policy measures to protect financial markets from widespread losses."

It is hardly surprising that people do not worry too much about abstract-sounding issues like moral hazard when much more immediate health hazards such as the coronavirus are dominating attention and debate around the world.

But financial hazards arise not only from actions on interest rates and other monetary accommodation. Central banks have enabled governments to finance fiscal stimulus to the tune of US$11 trillion during the pandemic, pushing total government debt to US$70 trillion, according to the Institute of International Finance.

This is not supposed to matter, according to modern monetary theory, because for those countries such as the United States that issue major international currencies, public debt issuance is simply an "accounting transaction" between the government and the central bank. Freed from restraints on "monetising" debt, governments can indulge in an orgy of debt issuance which they justify by the need to maintain aggregate demand.

Which brings us back to the dollar, with markets seeing a debased currency hardly worth the paper it is printed on. They are buying precious metals instead, and non-dollar currencies. This is dangerous because many things could fall with the dollar, from global reserves and trade, to banking and financial transactions and commodities.

The US could be the biggest loser. The exorbitant privilege it enjoys because the dollar is the global currency means the US does not face balance-of-payments crises while it imports in its own currency. But the dollar world could go the same way as the sterling area, into obscurity.


Anthony Rowley is a veteran journalist specialising in Asian economic and financial affairs.

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