Still Waiting for a Broad and Sustained Dollar Decline

October 15, 2019

Many forecasters had expected a downward break in the dollar this year. It didn’t happen, and only a fifth of the year remains. Compared to a year ago, the dollar shows a double-digit decline against the euro and rises of about 3% relative to sterling and the Chinese yuan versus a dip of less than 3% relative to the yen. Compared to five years ago, the dollar has advanced almost 29% against sterling and 16% versus the yuan. It’s also up by about 15% against both the euro and on a trade-weighted basis against other widely traded currencies.

Reasons for being guarded about the dollar’s prospects haven’t dissipated. The U.S. currency  enjoyed a good upward run that’s looking even longer in the tooth now than at the start of the year. The Federal Reserve did loosen monetary policy amid relentless criticism from the Trump Administration, although not exclusively in reaction to that factor. U.S. growth prospects seem more fragile than such appeared in the summer of 2018, and usable policy counter-measures to support growth look limited. With only a year remaining before the presidential election, an impeachment investigation of President Trump fraught with uncertainty has begun, and some of the economic, demographic, and political properties that decades ago made the dollar the king of reserve currencies no longer seem appropriate. If governments around the world were to start anew  to design an international monetary system, it seems doubtful that they would select as the centerpiece a currency of a government that debases the rule of law both internally and in its display of greater comfort with authoritarian rulers than leaders of other democracies.

But 2019 isn’t 1944 when it was necessary to design a postwar monetary system. It was much easier to start from scratch when the old system had literally been blown apart than to change arrangements that have become progressively more interdependent over many decades. Likewise, Fed easing has been merely part of a widely shared global trend toward monetary stimulus. Growth, inflation, and interest rates have dropped in many places around the world. America’s faction-riddled politics is no more intractable than Britain’s, and nationalism is a big force throughout Europe where recession is a more immediate danger than in the United States. Japan repeatedly fails to lift inflation to 2%, and China’s successful reinvention of its economic engine has been complicated greatly by U.S. tariffs.

Multi-dimensional uncertainty that appears more rooted than transitive is one compelling explanation for the dollar’s persistent strength. As a safe-haven, the U.S. currency habitually seems to be lifted by event news that adds to the pile of uncertainty. A problem with this explanation, however, is that the dollar didn’t always behave like a refuge for safety-seeking money. At the other end of my four and a half decades of currency market watching, Watergate and oil price shocks played havoc with the dollar. Back then, the club of then-called “hard currencies” had three charter members — the Deutsche mark, the Swiss franc, and the Japanese yen — and the dollar was on the outside looking in despite being the most widely used reserve currency.

Perhaps the biggest disconnection between then and now  is the shift from a world of high inflation and expectations that restoration of price stability would continue to slip further away to a new landscape of excessive disinflation that appears just as chronic as high inflation did once. It’s important to understand that this is not just a statement about U.S. conditions but rather a global phenomenon. Yes, U.S. consumer prices between end-1973 and end-1974 soared 12.2%, but consumer prices in that year also advanced 25.3% in Italy, 21.9% in Japan, 19.2% in Great Britain, 15.2% in France, 12.5% in Canada and even 5.9% in Germany. Six and a half years later, inflation was still out of control, with consumer prices in the twelve months through mid-1980 climbing 21.0% in the U.K., 20.7% in Italy, 13.2% in in France, 8.4% in Japan, 6.0% in Germany, 10.1% in Canada, and 14.5% in the United States. A vicious cycle of high global inflation chasing higher expected inflation and back again helped foster a very unfavorable backdrop for the dollar.

Empirical observations have changed so radically between then and now that to quote from the Economist’s special survey on the world economy in this week’s issue, “economists are increasingly willing to question the dictum set out by Milton Friedman in 1963 that inflation is a monetary phenomenon. A decade of below-target inflation suggests that ‘what was previously treated as axiomatic is in fact false’ according to Larry Summers and Anna Stansbury of Harvard University. ‘Central banks cannot always set inflation rates through monetary policy.'”

One has to wonder if old truths regarding currency determination, i.e. the external value of money, ought to be discarded too in the face of such a profound evolution of the dynamics underlying the internal value of money.

Copyright 2019, Larry Greenberg. All rights reserved. No secondary distribution without express permission.





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