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Sunday, September 25, 2022

The US dollar is in decline: Here’s why and what to do.

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josef san jose
an ordinary man trying to do extraordinary things

The US dollar has been falling since March and has been on a high-speed downturn since late June. In fact, the index that calculates the greenback against six other major currencies is down nearly 9% from its March highs and is on track for its worst month since 2011. 

The US dollar has been largely overvalued for quite a few years which eventually led to its drop in the past months. At its March peak, the US Federal Reserve’s own broad US dollar measure against a wide range of emerging and developed currencies was nearly 25 percent above its 25-year average, although most other benchmarks were admittedly not quite as excessive. It is likely the US dollar would have had to go down at some point. Currency strategists at Goldman Sachs now predict a 5% weaker dollar compared to other major currencies in the world next year.

Although the decline of the US dollars’ value is swift and significant, this is not a long-lasting shift yet. In reality, the greenback’s slump is driven by several reasons, which are mostly to do with cyclical and unintended developments in the global economy, rather than any permanent earth-shaking changes.

Ironically, before its recent retreat, the US dollar climbs to a new high earlier this year as a sanctuary for investors in the pandemic. The world’s reserve currency advanced in a big way from a flight-to-safety, which drove it to a three-and-a-half-year high in March as the coronavirus pandemic is starting to spread in the U.S.

As panic has receded, it has allowed fundamental “cyclical” drivers of currencies to take over and depress the US dollar. Currency strategists say the dollar’s slide is because the U.S. is trailing most of the world in stopping the spread of the CoViD-19, the failure to control the virus means more businesses cannot operate normally, resulting in more business failures and a more lethargic economy. Some also expect the U.S. economic rehabilitation to trail other developed economies, including Europe, which makes the Euro an alternative for currency investors.

The dollar is also reacting to the anticipation of mounting U.S. deficits and ultra-low U.S. interest rates well into the future. The enormous U.S. fiscal deficit, at a trillion dollars to start the year, has inflated into a record $2.7 trillion for the first nine months of the fiscal year 2020 as the U.S. invest to fight the coronavirus. The decline of its interest-rate advantage makes the US dollar less palatable too and drives investors to examine deposits in other currencies. The market is also trying to assess the possibility of inflation, with all the global stimulus aimed at the crisis. These cyclical factors won’t turn around even after the pandemic and the US dollar likely has room to crash further.

To the investors, a weak dollar will lead to a rush to gold, which last stood at $1,947 per ounce today, almost close to its record high of $1,980.5 per ounce. This is because when the value of the dollar reduces relative to other currencies throughout the globe, the price of gold tends to advance in dollar terms. The gold rally has also been fueled by central bank stimulus and fears of inflation, not just the falling dollar. 

And with gold prices near an all-time high, it seems reasonable for investors to pick gold mining stocks. The stocks of multinationals also gain from a weaker dollar because it makes the value of U.S. goods and services competitive in foreign currencies. Per Goldman’s David Kostin a weaker dollar is also good for the broader stock market, a 10% fall in the value of dollar collectively increases S&P 500 company’s earnings per share by almost 3%. And when it comes to share price movement, since 1980, the S&P 500 has gained an average of 2.6% in months when the dollar declined versus 0.7% gain in months when the dollar increased sharply.

Companies that collect a majority of their earnings from overseas are the biggest gainers from a fragile US dollar. A strong dollar [PxxxT] tends to hamper product sales of such companies overseas. After all, they are exposed to foreign exchange risks between the United States and other countries they are operating in. 

A sluggish US dollar is a positive sign for risky assets in general since it usually occurs when both risk appetite is big and the global economy is expanding especially when investing in emerging markets like Asia. Emerging-market central banks can focus on delivering growth instead of keeping interest rates high to defend their currencies. Although solid Asian currencies may eat-away exporters’ profiteerings, this can be balanced by stronger demand globally and reduced import costs when serving domestic customers.

reports of the dollar’s death are greatly exaggerated” – Paraphrasing Mark Twain

There is no need to carelessly conclude that greenbacks’ days as the world’s dominant currency are numbered because of it’s sudden and considerable decline. The Euro and Renminbi will test the power of the US dollars but that will take many years and depend upon further economic renovation and liberalization from China and assurance-building from the EU.

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