Pandemic, Economy, and the Dollar

April 6, 2020

Currency market participants are in an unprecedented period whose evolution will be decided foremost by an external factor involving a shock to the system in which even the experts have no first-hand experience. Although medical scientists have considerable familiarity dealing with other coronaviruses, there hasn’t been a respiratory pandemic in the last 102 years to match Covid-19 in combining the extremes of very high transmissibility and great lethality. Financial markets are learning about this disease in dribs and drabs, largely because there is much for scientists to yet discover and because the signals from politicians and scientists are often obtuse and sometimes inconsistent. Investors are used to dealing with uncertainties from a variety of factors, but rarely has the fate of economies and market prices been so singularly dependent upon an expertise beyond their normal skill set.

It’s clear nonetheless that much of the world has already succumbed to a recession of unknown¬† duration. The severity is going to be very great at least for a short span. Records will be broken, even some held since the 1930s depression. Second-quarter growth will likely be more negative than the worst quarters of the Great Recession. Beyond mid-year, things get very murky, but negative risks to growth even then seem to outweigh the likeliness of scenarios with better-than-expected growth.

  • Governments will probably err on the side of relaxing restrictions against social gathering later rather than sooner, because the consequences of giving the all-clear sign prematurely are so dire.
  • The pandemic has hit different geographical areas in a staggered way, and this property is likely to continue. Renewed social gathering that seems safe in one locality may in fact not be so, if in-travel cannot be prevented from places still highly infected.
  • Many small businesses and some mid-to-larger ones are unlikely to survive this pandemic, resulting in a stochastic drop in the supply side of the economy.
  • In activities that require social gathering, consumers may hesitate to venture out even after the all clear sign is given. Public trust in what authorities are saying was already very low coming into this year. Eventual encouragements to get out and spend may not persuade a lot of people that the danger has lifted.
  • The best way to restore confidence would be a proven safe and widely available vaccine, but that’s probably more than a year away. In the meantime, second waves of the virus might prove more deadly than this initial one. That’s what happened in 1918.
  • This year’s U.S. presidential and congressional election introduces a whole extra layer of immense distrust. So much is at stake (remember climate change?), and it’s pretty clear that groups both within and outside the United States are gearing up to distort the true outcome even more effectively than they did in 2016.
  • In the Great Recession, some developed economies kept chugging upward like Australia’s, and among developing economies, there were some stalwarts like China whose GDP expanded over 9.0% in both 2008 and 2009 as well as India, where GDP accelerated from 3.9% in 2008 to 10.3% in 2009. Global GDP contracted 1.7% in 2009 versus average growth between 2000 and 2007 of 3.4%. Covid-19 will affect more of the world than the Great Recession.

Even if we had 20-20 vision regarding the epidemiology of the Covid-19 pandemic and its differential impact on the many economies of the world, the outlook for the dollar would be far from clear. Four earlier mega-shocks produced different reactions in the dollar.

  • Following the first OPEC oil price shock soon around the start of 1974, the dollar swung significantly in both directions but without much conviction during the rest of the year.
  • In the aftermath of a 22.6% single-day plunge in the DJIA on October 19, 1987, the dollar fell 13% against the German mark and 15% relative to the yen over the rest of that year.
  • Over the six months following the 9/11 attacks in 2001, the dollar stayed unexpectedly stable versus the euro and yen.
  • The dollar weakened against the euro in the second half of 2007 and early 2008. The subprime financial crisis had begun, but the bulk of the Great Recession still lay ahead. As the recession took greater hold, the dollar rebounded against the euro but continued to falter against the yen.

While these precedents fail to give guidance to how the dollar might perform, a better indication perhaps lies in the dollar’s underlying current trend. The U.S. currency tends to travel in long waves of time. An international system of flexible dollar rates replaced one of fixed parities in the spring of 1973 during a time of dollar vulnerability. Bouts of depreciation continued for the rest of the 1970s, were followed by a golden dollar age from early 1980 until early 1985, but only to to see all such gains vanish by end 1987.

More recently the dollar has been in a broad uptrend since the summer of 2011. The currency’s well-bid tone reflects a global tightness of dollar liquidity that has been accentuated by the Covid-19 pandemic. As an unchallenged paper currency in multi-asset portfolios, the dollar is the natural go-to currency in times of extreme risk aversion. Unless the U.S. government badly botches the handling of this crisis both absolutely and relative to the experiences in other major economies, the dollar would seemingly be well-supported over coming months. But make no mistake, the coronavirus pandemic introduces a highly uncertain dominant force into the equation that leaves many outcomes reasonably possible.

Copyright 2020, Larry Greenberg. All rights reserved. No secondary distribution without express permission.



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