The tumbling dollar has the pundits buzzing.
The greenback is down 5% from a year ago against a basket of currencies and down nearly 10% since mid-March against the euro. A weaker dollar is good news for the United States’ agriculture exporters. Is it a bad sign for the country’s position in the world?
The usual explanations for a declining currency are economic: a slump in gross domestic product (GDP) growth, a worsening trade deficit or inflation. When the slumping currency is the dollar, pundits inevitably start wondering whether the decline signals the end of the overpowering international influence of America, or at least of the American dollar.
Sure enough, we’re starting to see headlines like this one in Barron’s: “America’s Economic Model May Have Peaked. The Dollar’s Strength Goes With It.” Or this one from the New York Sun: “Doubts Emerge Over Dollar’s Role As a Reserve Currency.” A thestreet.com headline put it: “Death of the Dollar Theories Circulate Endlessly.”
These speculations may be wrong but they aren’t irrational. The US has been the world’s most powerful country for a long time but its power has steadily declined since the immediate post-World War II years, when it peaked.
Much of this decline is relative; it reflects the growing strength of other countries – Germany, Japan and, most recently, China. Some of it is self-inflicted wounds, like the Vietnam War disaster, the 2008 financial crisis and our floundering response to Covid-19.
A strong country usually has a strong currency. A weakening of its currency doesn’t, however, necessarily foretell a permanent erosion of the country’s international influence. The weakness could be cyclical, meaning the currency will turn around in a matter of months or years.
But when the country has been running big trade deficits and government budget deficits for decades, pundits sniff further national decline. At the very least they wonder how a country that perpetually lives beyond its means, consuming more than it produces, could possibly have the world’s reserve currency.
Every time they’ve wondered this in the past the dollar has rebounded. Will it this time? Can it continue to be the world’s reserve currency? Recent articles in the Economist and the Wall Street Journal provide some interesting insights.
The Economist thinks that “America is not as weak relative to its rivals as often assumed. American politics are dysfunctional, but an often-fractious euro area and authoritarian China inspire still less confidence.”
The main threat to the dollar’s reserve currency status, the Economist argues, is the Trump administration’s abandonment of the network of alliances and international institutions that the US built over the last seven decades. The Economist cites academic research indicating that America’s geopolitical influence is a key reason for the dollar’s status.
“An American-led reconstruction of global trade could secure the dollar’s dominance for years to come,” the Economist opines. “A more fractious and hostile world, instead, could spell the end of the dollar’s privileged position – and of much else besides.”
The Wall Street Journal article sees a different reason for thinking the dollar could continue to reign: the Federal Reserve’s recently assumed role as the world’s banker of last resort.
The article chronicles how the Federal Reserve prevented the world financial system from seizing up earlier this year after Covid-19 sent companies and investors on a desperate “dash for cash.”
In the scary market weeks between mid-March and early April, the Fed lent half a trillion dollars to its counterparts overseas.
“The massive commitment was among the Fed’s most significant – and least noticed – expansions of power yet,” the Journal reports. “It eased a global dollar shortage, helped halt a deep market selloff and continues to support global markets today. It established the Fed as global guarantor of dollar funding, cementing the US currency’s role as the global financial system’s underpinning.”
A top Bank of England official said the Fed’s lending “may be the most important part of the international financial stability safety net that few have ever heard of.”
Congress could revoke the Fed’s authority to lend overseas if it disapproved but the Journal reports that, when Fed chair Jerome Powell testified before Congress in June, “lawmakers didn’t ask a single question about the huge sums the central bank made available to borrowers abroad.”
The risks to the Fed are minimal; the loans are to “the most creditworthy nations and advanced central banks.” There are downsides, though. One is that it requires the independent Fed to coordinate with political agencies on foreign policy. There will be countries the White House won’t want the Fed lending to.
Another is that the world becomes even more dependent on the dollar. Knowing that the Fed will provide dollars in a crisis, people overseas will be ever more tempted to borrow in dollars.
That exposes them to foreign exchange risk and leaves them vulnerable to Federal Reserve interest rate decisions made to support America’s domestic economy, without regard to whether they’re the right medicine for overseas economies.
If America’s geopolitical influence continues to wane, the dollar at some point could be supplanted by the yuan or the euro or some other currency. But for now, despite the potential downsides and despite its recent decline in value, the dollar seems likely to continue to be the world’s reserve currency.
Former longtime Wall Street Journal Asia correspondent and editor Urban Lehner is editor emeritus of DTN/The Progressive Farmer.
This article, originally published August 19 by the latter news organization and now republished by Asia Times with permission, is © Copyright 2020 DTN/The Progressive Farmer. All rights reserved.