EDITOR NOTE: This article, written from an Australian perspective, criticizes the US’s “bungled” response to the coronavirus pandemic, describing it as yet another factor that has driven away foreign investment and trust in the US dollar. By sacrificing its citizens’ health and well being in order to save the American economy and to keep the stock market rallying, the US has lost its “clout” on the world stage, and the dollar, no longer viewed as a safe haven, has already begun its slow exit as the world’s reserve currency. This, in the eyes of many nations, is a self-inflicted wound; and a terminal one.
The US dollar has crashed nearly 9 per cent since March amid fears that a confluence of circumstances, exacerbated by the Trump administration's bungled response to the coronavirus pandemic, could lead to a permanent downgrading of the greenback’s status as the world’s reserve currency.
The flip side of the US dollar’s devaluation has been a near 25 per cent spike in the value of the Australian dollar since its sub-58 US cent lows in March, but what’s occurring is far more of a US dollar story than one driven by particular perceptions of Australia’s economic condition.
The US dollar is, according to Bloomberg, on track to experience its worst July in a decade after reaching levels last plumbed more than two years ago against a basket of its major trading partners’ currencies.
As the US dollar has tumbled, the value of precious metals has soared.
The gold price, which historically has had an inverse correlation with the dollar, hit a record of more than $US2000 an ounce on Monday as risk-averse investors fled the traditional safe haven of US Treasury securities.
In essence, what’s occurring is a loss of faith in the US economy, its political system, its competency and in its commitment to the post-war role it has played in the world’s affairs.
America’s squandering of its global leadership and its rapidly deteriorating public finances provide no reason for the rest of the world to maintain the faith [in its economy].
The pandemic, after three and a half years of the chaos of the Trump administration, is a major factor in the dollar’s decline and in the emerging market concern that it might not be a short-term development.
Trump has completely mismanaged the crisis, with the virus still spreading across the US amid a cacophony of mixed and often misleading messages delivered by his administration. The looming presidential election is, of course, a significant factor.
The pandemic has also fed into and exacerbated a dramatic deterioration in America’s public finances.
After a federal budget deficit of almost $US1 trillion ($1.4 trillion) last financial year (as Trump’s tax cuts and spending flowed through) the $US1.9 trillion of the initial response to the pandemic and the extra $US1 trillion or so now being contemplated will swell the deficit to around $US4 trillion, or close to 20 per cent of America's GDP.
Relative to the GDP, the country's public debt will almost certainly top 100 per cent for the first time since the Second World War, when it peaked at 106 per cent.
The dramatic structural deterioration in America’s fiscal settings has added to the concern that the US is debasing its currency.
In response to the pandemic the Fed has cut US interest rates to almost zero and hosed the US financial system with $US3 trillion of liquidity and ultra-cheap credit.
US 10-year Treasury bonds yield only 0.58 per cent and two-year securities return 0.14 per cent. It is clear from the central bank's signalling that rates will remain at negligible levels for years and that the Fed is open to keeping them low even if inflation is rekindled.
The US rate structure has removed most of the positive yield arbitrage it previously enjoyed relative to other major bond markets, wiping out the carry trades that enabled hedge funds to borrow in Europe and Japan to invest in US Treasuries.
Where at the height of the global panicky response to the pandemic capital poured into the US Treasury market, it has more recently poured out.
Goldman Sachs went as far as to question the reserve status of the dollar, which accounts for more than 60 per cent of the world’s foreign exchange reserves. The vast majority of world trade is invoiced in US dollars.
There is significant benefit to the US economy --lower interest rates and unlimited access the world’s savings pools – from that reserve status.
The Trump factor
The Trump administration has frittered away some of the under-pinning of that “exorbitant privilege,” as it was once described, by abandoning America’s post-war position of leadership in the West.
Its trade wars on China and its allies under the “America First” banner, its assaults on the post-war global institutions it played the key role in creating and the incoherent and volatile nature of its policies towards the rest of the world, along with the sheer weirdness of the Trump years, have undermined faith in its sophistication, competence and integrity, while the escalation and spread of the hostilities with China are another destabilising factor.
In the past there have been few safe haven alternatives to the US bond market. Europe has been divided and dysfunctional since the global financial crisis, Japan has had three decades of economic winter and there have been sizeable interest rate differentials between the US and their financial systems.
That is changing. It isn’t surprising that the yen has strengthened in recent months as the yield gap has narrowed and it became clear that the country has weathered the pandemic far better than the US.
Europe, also emerging from the pandemic, has experienced a surge in the value of the euro relative to the US dollar, with the euro appreciating nearly 10 per cent from its March lows. There has been a particular spike in recent weeks as the agreement to create the €750 billion ($1.2 trillion) recovery fund created, for the first time, a pool of debt backed by all the European Union’s member states.
Europe has a far smaller bond market than the US – its companies fund themselves from the banking system – but the recovery fund will create a much deeper pool of bonds with far stronger creditworthiness and a direct alternative to US Treasuries.
China, of course, has been promoting its own currency, including a digital version. The renminbi has also strengthened significantly since it became evident that China was emerging from the pandemic ahead of most other economies.
The loss of the US dollar’s prestige not only offers an opportunity to others, but it could threaten other segments of the US economy and financial system.
If America can’t rely on its safe haven status to attract funds, then its ballooning borrowing requirements and dearth of domestic savings relative to that requirement may result in the market forcing higher interest rates on the US than might otherwise be the case, regardless of what the Fed does.
There is traditionally an inverse correlation between the dollar and the US stockmarket, but the US market has been inflated by the global search for positive returns in the low-rate post-financial crisis environment and the general perception of the US as a financial safe haven.
The US is vulnerable to any loss of foreign investor confidence in its economy and markets. Sadly, America’s squandering of its global leadership and its rapidly deteriorating public finances provide no reason for the rest of the world to maintain the faith.
Originally posted on SMH