Handicapping the Dollar Outlook in a Pandemic-Preoccupied Era

April 30, 2020

Projecting the dollar’s value has always been very challenging and humbling. Economic trend forecasting is hard enough, and anticipating the reaction of financial markets to different economic scenarios introduces a whole new level of uncertainty to the exercise. Market watchers this year have been dealing with a third broad complication and the most vexing of all. For a time span likely to extend past the end of 2020, economic trends and macroeconomic policy responses will continue to be dominated by the evolution of the Covid-19 pandemic. The scientific experts working on treating sick patients and finding a cure for the disease are not in a position to lay out with high confidence the timetable of what lies ahead.

Many questions related to Covid-19 remain a mystery. Can a test to determine a person’s likelihood of getting seriously ill from the disease be developed and made widely and cheaply available to the public? If so, then when? Will the virus mutate in a future wave to an even more lethal strain as did the Spanish flu? Will treatments for sick patients be developed that speed up recovery and diminish mortality? How quickly can different activities that require a degree of social gathering be resumed? Which activities must await a vaccine? As social restrictions get loosened, will businesses and consumer show the confidence to resume play even if safeguards are observed, short of a readily available vaccine? How many small businesses simply won’t survive this pause of undetermined length?

Another uncertainty concerns the U.S. election, now just six months and three days away assuming it is held as mandated by law. America is engaged in a civil cold war that makes it prone to commit policy mistakes that skew potential Covid-19 damages to the upside, albeit along an unknowable timeline.

The dollar has performed well during the pandemic, which isn’t surprising. Times like these benefit safe havens, and the dollar remains the preeminent currency safe haven. Moreover, the dollar enjoyed decent demand in the period leading up to the Covid-19 onset, so the shock merely needed to reinforce preexisting currency preferences. Significant dollar appreciation occurred during the first quarter against a number of developing and commodity-sensitive currencies, but changes relative to the yen, Swiss franc, and euro were rather limited both in the quarter and during April, too. Another key casualty of dollar strength has been sterling, against which the U.S. currency rose 3.3% in March and by about 2% this month.

Sterling’s problems point to a trend that bears watching regarding globalization. Globalization benefited the dollar’s value, and the U.K. in particular was going to need plenty of globalization to make a go of life outside the European Union. However, even before the pandemic was unleashed, popular support was waning for globalization. America First thinking epitomizes a counter-offensive against the forces of globalization, and changes necessitated by the pandemic are likely to enable those who would like to remake the international monetary system in a more nation-centric framework. This development is bad for sterling but in the longer run not good for the dollar either.

By turning its back on the role of leader of the free world and using the dollar’s hegemonic role in world trade and finance as a weapon of basic foreign policy, the Trump Administration is seeding enormous incentives for other governments such as China to promote lessening dependence on the dollar. The catch there is that workarounds are hard to find. As long ago as the 1970s when the U.S. was gripped by particularly high internal inflation and chronic external dollar debasement, there was speculation that the greenback would be supplanted by reserve asset alternatives. But a serious and enduring challenger never emerged, and the thinking now is that it could take decades if not generations for such a transformation to be accomplished. Here a final word of caution seems appropriate. Oftentimes when markets fixate on a forecast of something happening within a multi-year time horizon, the expected development in fact results much sooner.

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



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