Dollar Now and Where It Might Be Heading

July 15, 2021

By historical standards, the dollar’s trading ranges over the last twelve months have been atypically confined. Similar 52-week high-low spreads against the euro, yen, and Swiss franc respectively have been 8.5%, 8.8%, and 8.2%. Not surprisingly given those widths, the dollar has moved within an 8.1% band against the DXY weighted index. Presently the dollar lies 0.5% and 0.8% above the center of its euro and Swiss franc ranges, 0.2% below the mid-point of its DXY range, and 1.5% higher than the floor of its trading corridor vis-a-vis the yen.

There has been greater dollar movement over the past year against a selection of other currencies such as the Chinese yuan, whose high-low spread was 10.6% wide. Within that band, China’s currency presently stands 1.7% below its most appreciated point. 52-week high-low spreads have been 14.2% against sterling and 15.7% relative to the Australian dollar. The dollar is now 3% from the ceiling of its band versus sterling and 0.5% above the middle of the Aussie dollar range. One has to look to a currency like the Turkish lira to find a dollar relationship that’s experienced really remarkable movement over the past year. The dollar is presently just 2.5% from the top of its 29% high-low range against the woebegotten lira.

But to gauge the general health of the dollar, it’s best to compare the currency’s performance against the euro, Swiss franc, and Japanese yen. In the first three decades of flexible dollar exchange rates when actual and expected inflation differentials were an important determinant of currency valuation, the yen, Swissie, and Deutschemark were collectively referred by the term “hard currency” because of their shared abilities to strengthen externally over time. That characteristic stemmed from monetary policies that prioritized preservation of the internal value of money, i.e. low inflation, above all other economic goals. Where significantly different inflation rates prevail between currencies, the internal and external values of money tend to move in tandem.

This relationship has been less determinant in the 21st century. That’s mainly so because inflation differentials have been substantially more narrow. The Deutschemark is no longer, but it would be incorrect to think of the euro as either the average of its many parts, or even as no more durable than its weakest link. This is because the European Central Bank was created in the image of the Bundesbank. All of which brings one to back to considering the dollar’s future, which seemingly revolves around whatever scenario one imagines to be the most likely future evolution of inflation and central bankers’ reactions to inflation.

In the 1970s when Fed policy vis-a-vis U.S. inflationary pressure was only reactive and thus perennially behind the curve, the dollar trended lower against the hard currencies and even a number of softer monies that were nonetheless tied to the mark. To be sure, there were interruptions in the decline of the dollar and acceleration of U.S. inflation, both absolutely and in relation to inflation rates elsewhere. But setbacks in the dollar tended to outdistance those times of recovery. And the dollar’s weakness didn’t necessarily correlate with slow U.S. economic growth. Real GDP grew at a robust 3.2% annualized rate during the presidency of Jimmy Carter, notwithstanding a recession during the first half of 1980.

After 1980, the converse relationship between the dollar on the one hand and U.S. Federal Reserve tolerance for inflation on the other. The Fed committed to doing whatever it took to reestablish price stability in America, and that meant, firstly imposing interest rates that were above the rate of inflation, secondly leaving those rates well into double-digit territory for an entire year after the U.S. economy had entered recession and thirdly, staying ahead of the policy curve for several years thereafter.

The recession of 2020 was unlike any previous recession both in cause and policy response, and among the biggest current debates among economists is how transitory the rise in U.S. and world inflation will prove, whether current Fed policy is appropriate, whether officials will modify policy toward less stimulus in a timely way if it turns out they have misjudged the trajectory of inflation, and how quickly any policy mistake when rectified can restore investor confidence in the central bank.

Other things in the United States are very different from when America was gripped by high inflation in the 1980s. Politics are their most polarized in a century and a half. Enormous challenges are faced from severe income and wealth inequality, from climate change, from aging infrastructure, from strains over immigration policy, from monopolistic forces unleashed on the internet, from geopolitical threats from China and Russia, from anarchy-promoting activities of domestic and foreign terrorist groups, from uneven public education, and from the prohibitive cost of childcare. America’s high standard of living in the last two decades of the twentieth century was maintained by the influx of women into the labor force. Total employment climbed 1.83% per annum each in the successive decades of the 1980s and 1990s.

The Great Recession, the pandemic, and high cost of childcare put an end to that rapid rise in jobs growth. If the growth pace of non-farm payroll jobs had been maintained after 1999, there would now be over 192 million employees, not 145.8k. To sustain living standards, productivity would have had to neutralize the slower increase in hours worked. It didn’t.

The comparative stability of dollar rates over the past year appears to reflect a preponderance of uncertainties. If America remains at war with itself, it’s very hard to imagine the dollar retaining its current central position in international trade and finance. Until very recently, that hegemony was considered a lock for the next generation or two. But other big shifts both in the natural world and in interpersonal relations have transpired even faster than experts imagined. Be careful out there and be prepared.

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

 

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