The “dollar-is-crashing” trade is the ultimate widow-maker. For decades, it’s confounded more punters than bets against Chinese stocks, Japanese debt and Hong Kong property combined.
Yet might it soon pay off, finally, thanks to Donald Trump’s blunderbuss of a White House? The odds don’t favor it, at least for now.
Neither Trump pushing US debt past the US$25 trillion mark nor his trade war nor his disastrous response to the coronavirus has tanked the reserve currency. The reason, of course, is a dearth of trusted alternatives.
Yet the famous, or infamous, observation by Nixon-era US Treasury Secretary John Connolly that the “dollar is our currency, but it’s your problem” is truer in the Covid-19 era than it was in 1971.
And warnings from Zhu Min, the former deputy managing director of the International Monetary Fund, are hard to ignore, and even harder to dismiss. Zhu, now at Beijing’s Tsinghua University, points to runaway spending by President Trump’s Washington and the Federal Reserve’s ginormous easing campaign.
“The concern isn’t whether the US dollar will see an accumulated decline of 30% in the future, but whether there will be a blow-up event that causes a sudden loss of confidence in the US dollar, and its market to collapse,” Zhu told the South China Morning Post.
But for context, such worries are not entirely new.
In the mid-2000s, Joseph Quinlan of Bank of America Merrill Lynch warned the “rogue nation” policies of then-President George W Bush might wreck confidence in the dollar.
Economist Nouriel Roubini talked out a “nightmare hard-landing scenario” that would make markets “abandon the dollar” before and after the 2008 “Lehman shock.”
In 2009, then-Chinese Premier Wen Jiabao resorted to public pleas to Washington as post-Lehman US spending skyrocketed.
“We have made a huge amount of loans to the United States,” Wen said at the time. “Of course, we are concerned about the safety of our assets. To be honest, I am a little bit worried.”
He urged the US “to honor its words, stay a credible nation and ensure the safety of Chinese assets.”
Wen looked prescient two years later when Standard & Poor’s yanked away America’s AAA rating.
Even then, though, the dollar did not collapse as feared. Beijing’s dollar holdings, 11 years later, are still north of $1 trillion. The reason, many claim, is a lack of highly liquid alternatives.
More recently, Stephen Roach of Yale University has hit the speaking circuit to argue that the “TINA defense” – “there is no alternative” – is no longer operative.
“If TINA is the dollar’s only hope, look out below,” Roach wrote in a recent Bloomberg column. “America’s saving and current-account problems are about to come into play with a vengeance. And the rest of the world is starting to look less bad.
“Yes, a weaker dollar would boost US competitiveness, but only for a while. Notwithstanding the hubris of American exceptionalism, no leading nation has ever devalued its way to sustained prosperity.”
The savings rate argument is becoming more complicated. In May alone it soared to 23.2%. That arguably is a healthy development in the longer-term context. It’s also helping to narrow America’s deficit.
Yet it’s an economic growth killer in summer 2020. The swiftness of any recovery requires households to spend again. If too many save the $1,200 checks Congress sent out or don’t spend their topped-up unemployment benefits, America’s recession could be ever deeper and longer-lasting.
Against this backdrop, Zhu’s warnings are worth exploring. One concern is the surge in corporate borrowing thanks to ultralow interest rates since the 2008 global crisis.
In a recent report, investment firm Janus Henderson reckoned that America accounts for nearly half of all corporate debt, roughly $3.9 trillion. That after the fastest buildup anywhere over the last five years.
The Fed, meantime, is gobbling up corporate debt so rapidly that it’s now anyone’s guess where the central bank’s balance ends and corporate America’s begins.
As we’ve seen with Japan since 2000, though, free money deadens the private sector’s innovative energy. There’s also no saying how many US companies might go bust if the Covid-19 fallout intensifies.
“So, the question of whether there will be a financial crisis will depend on whether a major company will be the next to go bankrupt, and thereby result in a jump in the corporate default ratio, leading to a sovereign debt crisis,” Zhu, a top IMF decision-maker from 2011 to 2016, says.
It’s striking indeed how quiet officials at Moody’s Investors Service and Fitch Ratings have been in recent months.
With the US borrowing untold trillions of dollars for stimulus purposes, investor trust in the dollar may be dwindling. Where are the downgrades? Part of it is fear of quaking global markets.
Credit rating companies may worry action now could catalyze a credit crisis worse than in 2008.
Trump’s erratic behavior, though, and the dollar’s worsening fundamentals, make you wonder why Asian central banks would add to stockpiles of US currency. As the US throws additional trillions of dollars at a slowing economy, the presumption is that Washington’s Asian bankers will continue financing these imbalances.
On one level, it’s a reasonable assumption. Discussions about Beijing and Tokyo holding so many dollars are often framed in terms of Asia’s leverage over the White House. But it’s a double bind and Asia is also trapped.
The slightest whiff in markets that China or Japan were trimming their exposure would kick off the very sell-off of which Zhu warns.
This giant game of chicken leaves the global financial system on tenterhooks, and the dollar vulnerable to sudden shifts in sentiment.
In March, for example, the dollar skyrocketed as coronavirus panic favored safe havens. The US currency is now having its worst month since early 2018. It’s down 2.6% versus the yen so far this year, and also losing muscle vis a vis the euro.
Plunging US growth, negative rates, Washington’s currency shenanigans over the years and 4 million-plus Covid-19 cases are creating a perfect storm of sorts almost sure to drive the euro, yen and yuan skyward.
“The endgame must be the US dollar losing its lofty position at the apex of the system,” says Charles Gave of Gavekal Research. That process, he says, “began in and around 2005 as the US moved to ‘weaponize’ the dollar, thereby ensuring the renminbi’s emergence as a competitor.”
Gave’s reference is to the efforts in Washington to weaken the dollar in order to make it more friendly to US exporters.
The Fed’s extreme laxity, meantime, augurs poorly for US exchange rates. “We see demand for greenbacks coming off on the Fed’s expanded balance sheet and ongoing fiscal stimulus,” says George Boubouras, head of research at K2 Asset Management.
It doesn’t mean the dollar crash predicted countless times these last 20 years is imminent. At the very least, dollar bears may be holding their collective breaths hoping Americans elect a less incompetent leader come November – and are thus reluctant to hit the “sell” button for now.
Yet the risk of a reckoning is rising along with awareness of how the Trump era is exacerbating all of America’s imbalances, and creating new ones few could have predicted.
The dollar-crash trade might not pay off in the short run. When it does, though, the fallout is going to make global financial crises great again.
And it could very well earn one Donald Trump a legacy he did not anticipate: The US president who handed global reserve-currency status over to China.