Stephen Roach, the former Chairman of Morgan Stanley Asia, sounded the alarm on the dollar. In particular, he expects a 35 per cent fall in the US dollar index and a legitimate challenge to the dollar’s status as the world’s leading reserve currency.
The dollar’s 35 per cent fall is not unprecedented. The dollar fell by a similar amount in the 1970s and mid-1980s, falling as much as 30% in the early 2000s.
Why is the dollar falling now? Roach says there are three main reasons for the recent decline in the DOLLAR index, apart from some short-term trading factors:
First, the US net saving rate, already in decline, will fall further as the fight against the COVID-19 pandemic leads to a huge increase in fiscal deficits. Mr Roach points out that the US has an outbreak with a domestic savings rate of just 1.4 per cent of national income. Because of the huge new budget deficit, he expects us to see a negative savings rate of between -5% and -10%. The US current account deficit looks set to soar.
Second, Roach argues that America has squandered its global leadership in many ways — anti-globalization, protectionism, novel Coronavirus, and so on.
He noted that the United States had given up its global leadership role. Unfortunately, the US has recently led the way in protectionist trade policies such as deglobalisation, advocating decoupling and imposing tariffs on China. The US has actively undermined its own support for global institutions such as the World Trade Organisation and the World Health Organisation, while also damaging relations with Canada and Its European Allies. Compared with other countries, the United States has done the worst in curbing novel Coronavirus, which is important in assessing currency risk. At the same time, the United States faces systemic racism. America has always looked superior to other countries, but it is not.
Moreover, there are many other currencies besides the dollar — including the euro and the renminbi.
Roche thinks the euro will rise in the future. It has now appreciated in value. Unlike the overvalued dollar, which is still about 30 per cent above its 2011 low, the euro is undervalued. European leaders agreed on a comprehensive recovery plan for the European Union on July 21 after intense negotiations. The plan provides for a pan-European fiscal policy and includes provisions for member states to issue sovereign bonds for financing. Just as during the sovereign debt crisis the European Central Bank said it would do “whatever it takes” to save the euro, this time Europe’s political leaders surprised everyone by moving to start addressing the fiscal union that has long been absent from Europe’s economic and monetary union.
As a result, Mr Roach sees the dollar in the early stages of a major correction over the next few years, likely to be a 35 per cent fall in real terms, thanks to us macroeconomic imbalances, the loss of global leadership and the strength of the euro. This will soon be proved.
It is worth noting that dollar depreciation is likely to take place over a relatively short period of time rather than over a longer period of time (10 years or more). Roach believes that this NOVEL Coronavirus decline will be a short but intense process as it speeds up a lot of things. The global economy has come to a screeching halt in two months, and he thinks the currency markets could do the same.
Over the past few years, the dollar has held up reasonably well as markets have viewed the US as “different”. Foreign investors have been willing to pay a premium for the dollar. But the roses may be over, so to speak.
Last month, the dollar plunged more than 4 percent, hitting the market hard. The dollar index, which measures the greenback against six other major currencies, is down about 9% from its March high. Hedge funds warn that shorting the dollar is now a crowded trade.
For foreigners, a weaker dollar means two things. First, they could finance a widening US current account deficit by buying more US assets, including Treasuries, with less local currency. Second, a weaker dollar makes American assets more attractive to foreigners.