Dollar Outlook Quite Confused

November 30, 2020

In a year of enormous social and economic stress, net dollar movements since the end of 2019 have been extraordinarily muted.

Many economies recorded contractions in the second quarter followed by record positive growth in the third quarter. Close to 1-1/4 million people globally have died from Covid-19, and the disease that first surfaced a year ago has intensified with the approach of winter as many experts had predicted. U.S. President-Elect Biden had pitched November’s election as a moment of truth for voters to either agree to let democracy die or continue, and President Trump’s refusal to concede the outcome’s legitimacy underscores the accuracy of Biden’s characterization.

In the floating exchange rate system that evolved almost a half century ago, currencies are determined by shifts in market forces that in turn hinge on perceived economic trends and expectations regarding future possible political surprises and policy changes. A great deal of uncertainty hung in the air all year. The unpredictable ebb and flow of the pandemic was the driving force on economic activity, and the U.S. presidential choice offered America and the world two plans of governance that could not possibly have been more different.

Nonetheless, dollar changes since the start of 2020 have been astonishingly inconsequential. In trade-weighted terms, the dollar is a mere 3% weaker. On a bilateral basis, the dollar over these 11 months fell less than 1.5% against sterling, the Canadian dollar, Korean won, and Polish zloty; by 2.5-5.5% versus the Chinese yuan, Japanese yen, kiwi, Australian dollar, and Czech koruna; and by 6.1% relative to the euro, 6.3% vis-a-vis the Swiss franc, 6.5% against the Danish krone, and 8.5% versus the Swedish krona. Small upticks were recorded of 3.6% against the Indian rupee, 2.1% versus the Indonesian rupiah, 1.2% against the Thai baht, and 0.2% versus the Norwegian krone, and larger advances occurred of 7.9% against the Peruvian sol and 6.7% versus the Colombian peso. A couple of massive appreciations — 33.8% against the Turkish lira, 35.7% against the Argentine peso, 33.1% against the Brazilian real, and 23% relative to the Russian ruble — reflected wide inflation disparities and/or the flipping of big dollar declines in 2019.

Alas, the 2020 U.S. election did has not flushed away all the ambiguity that kept investors marking time. The here and now of the pandemic involves high levels of new cases, hospitalizations, and deaths. Covid-19 poses danger to all parts of the world but on an uneven and unpredictable basis. Vaccine availability will come on stream in the first half of the year, but in a staggered way, directed initially at groups where the most lives can be saved. There will be resistance to getting a vaccine by some, and among certain segments of the population, by many. It remains highly unreliable how all this translates into a tipping point when a majority of people feel confident to engage in social activities that they now are not doing. From the standpoint of anxiety over public health, I suspect that 2021 on the whole will resemble 2020 more than 2019.

Political uncertainty also looms very large as one peers forward. The senate is more likely to be controlled by Republicans than Democrats, and the outgoing Trump Administration is doing its hardest to shield policy changes it made from being reversed. Trumpism remains well entrenched, and numerous ways exist for President Trump after January 20 to control the Republican Party and to hinder President-Elect Biden and his team from controlling the 24-hour news feed. Valuable time is already being lost in legislating a properly designed fiscal stimulus. Without such, it’s quite plausible that the United States double dips into recession. And if America continues to appear at war with itself, investor doubts will fester about the reliability of Washington as a foreign policy ally. Trust the United States as the world’s strongest nation and in the brand of American democracy may erode further.

A currency lesson from the first fifth of the 21st century is that it may take huge and sustained damage to America’s image to topple the dollar’s role as linchpin of the international financial system. The dollar was not sent reeling by a made-in-America global financial system crisis, a dangerous brush with autocracy, the most dysfunctional congress in over 150 year, a propensity to extremism on the political right, or the rapid emergence of an ambitious and economic rival in China, which has also proven more adept than the United States in crisis management.

Currency markets have also been predisposed to reward short-term performance. Similar to the Great Recession, the U.S. economy this year suffered a comparatively smaller downturn and then recovered more quickly than many other Western countries for the summer. This gives continuing comfort to holders of dollar-denominated assets. In the pandemic so far, the dollar has worn the flight-to-safety hat well. So long as the world economy seems beholden to the continuing vagaries of the pandemic, the dollar would seem positioned to avoid worst-case situations such as what befell it during the inflationary 1970s. A sustained big move upward also seems unlikely. Like 2020, choppy market conditions are apt to persist.

But the final caution is this. There are no guarantees in foreign exchange. Forecasting currency movements has always been a sobering game. If America fails to get its political house in order, the dollar’s intangible underpinnings like the rule of law, a powerful military, sound economy, financial market depth and breadth, and political stability will grow weaker. France’s Ancien Regime, Germany’s Weimer Republic, and Czarist Russia serve as some of the historic examples of political collapses that happened very quickly and in helter-skelter fashion.

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




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