Dollar in a Challenging Situation

January 7, 2021

The dollar depreciated much of the time last year, dropping from end-2019 to end-2020 by 9.0% against the Australian dollar, 8.2% versus the euro, 6.2% relative to the Chinese yuan and 5.0% against the Japanese yen. Those losses mask a well-bid first quarter that saw the U.S. currency attain its best trade-weighted value for the year late in March. From that cyclical high, the dollar had lost 5.4% by midyear and marginally more than 13.0% when it touched this year’s low two days ago. Putting the dollar in historical perspective, it is currently 28% weaker than  its 1985 high but still 27% above its February 2008  low — in other words, around its range middle.

The end of 2020 didn’t appear to give the dollar a fresh slate. In the first three and a half days here in New York, the dollar had slipped 0.4% against the euro. That might not sound like much, except that the first half of January has often been a time of seasonal dollar strength. In the formative years of flexible dollar exchange rates, the dollar advanced during the first half of January in ten of fourteen years from 1975 to 1988 against the German mark. It climbed 0.9% on average in that season including those four times when it depreciated. (At that time, DEM/USD was the most important bilateral dollar relationship just as the euro is presently). Later after many European governments including Germany’s merged their currencies into the euro, the dollar also rose on average by 0.9% against the common European currency from 1999 through 2014.

More recently, this seasonal pattern of dollar strength against the euro coming out of the yearend gate has been less pronounced. After rising 4.0% in 1H January 2015, it fell in the first half of month for three straight years — 0.4% in 2016, 1.1% in 2017 and 2.1% in 2018 — before rising 0.3% in 2019 and 0.6% a year ago at this time. Compared to its closing on December 31st, it’s now down 0.4% but at Wednesday’s low was showing a 0.7% drop.

Economic factors that depressed the dollar last year have been sustained. The ten-year U.S. Treasury-minus-German bund yield differential narrowed 62 basis points between end-2019 and end-2020. The United States is perceived to have a twin deficit problem now, just as it did in several earlier cycles of dollar depreciation. November’s trade deficit reported this morning was $5 billion larger than October’s, and the $604.8 billion January-November trade gap was 14% wider than in the first 11 months of 2019. The federal budget deficit had ballooned in the wake of the 2018 tax cut and then super-soared this past year as a result of appropriate fiscal relief to counter the mishandled Covid response. With the Federal Reserve committed to lifting inflation above the 2.0% long-run target, say to around 2.5%, and still a long way from achievement of that goal, substantial monetary stimulus will continue throughout 2021.

Public sector incompetence during the Trump years also puts the dollar in some peril. The national response to the pandemic was woefully inadequate. During the Spanish flu pandemic a century ago, the United States accounted for 1.35% of global deaths, but America’s share of global Covid deaths is 19.53%. America fouled up the distribution of PPE equipment, the messaging on masking, testing and tracing, and now seems all flummoxed over the distribution of vaccines. Make no mistake, the pandemic poses a test to national security no less than a foreign threat. If all-around competence in 1941-45 had been at the current caliber, the second World War probably would have been lost. Trump’s on the way out, but his legacy of neglect will go on haunting America’s image.

Another vital element that allowed the dollar to fill the linchpin role in today’s international monetary system was unrivaled investor confidence it its political rule of law. Transitioning power had been always peaceful until this time.  Faith in the rule of law has been shaken even more badly since November’s election than in the four prior years. The argument dismissing this problem as a dollar negative is that the world has no reasonable alternatives to its reliance on the dollar, and that’s certainly true for the shortest of time intervals. Like bull markets that go bust in a hurry, political stability can unravel much faster than imagined. The mob storming the Capitol Building yesterday was a frightening spectacle, conjuring up the central role of crowds during the French and Russian revolutions, neither of which went well.

The dollar enters 2021 in shaky waters not because current exchange rate levels find themselves at historical extremes because they are not. Rather, the backdrop of economic fundamentals are not currently ideal and, more importantly, intangible additional supports for confidence are facing an uncertain moment over what’s next in the American experiment in democracy and a mixed economy where capitalism plays by the rules and flourishes for all.

Copyright 2021, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

 

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