Is a Dollar Crash Coming?

SOME ARGUE (see "The end of the dollar's exorbitant privilege" by Stephen Roach, Financial Times, October 5, 2020) that America's plunging net domestic saving and ballooning current account deficit put the overvalued dollar at severe risk. As deficits and debt accumulate further and the current account imbalance deepens, the risk to the dollar will intensify. Do you agree?

The U.S. federal debt, now at $27 trillion, is scheduled to rise a lot further as presidential campaign promises are met and coronavirus-related costs escalate. What are the chances U.S. federal debt will ever be paid off? After all, the president of the World Bank has already proposed debt forgiveness for developing world economies. Is the next step global debt restructuring?

The entire developed world is bogged down in unprecedented levels of debt, the Covid-19 crisis is not over, and the major central banks' balance sheets have been massively expanded. What is the end game to this global situation in what is still a dollarized world?

Nearly thirty noted analysts share their views.

SCOTT BESSENT

CIO and Founder, Key Square Capital Management

In a typical U.S. recession, the current account improves markedly as consumers restrain spending and imports contract. However, in this latest recession the current account has widened by nearly 1.5 percentage points, as consumers flush with stimulus have shifted consumption away from domestically produced services towards more import-intensive goods. Indeed, stories abound about a critical shortage of shipping containers needed to ship consumer goods from Asia to the United States amid surging demand.

Naturally, this backdrop has led observers to conclude that a dollar crash is imminent, as government debt expands and the balance of payments deteriorates in kind. Over the short to medium term, such a crash is unlikely. Rather, the currency is likely to face a steady but prolonged period of depreciation as the structural supports that have boosted the dollar begin to fade.

Broadly speaking, the most recent upcycle has been buoyed by three pillars. First, the shale revolution allowed the United States to achieve energy self-sufficiency in 2019. Mechanically, this generated a major improvement in the trade balance and led to a shortage of dollars abroad. However, the world is on the cusp of another energy revolution, a green one. Here, the leadership role of the United States is less clear, as Europe and China possess many of the key technologies. As these technologies are adopted over time, this will erode the relative energy advantage of the United States.

Second, U.S. growth outperformance following the global financial crisis allowed the Fed to normalize monetary policy as many other developed-market central banks remained stuck at the zero lower bound. Prior to Covid-19, this opened up wide interest rate differentials that encouraged U.S. inflows. However, these interest rate differentials have now contracted substantially. And with the Fed likely on hold for many years, they are unlikely to widen again soon.

The final factor boosting the dollar has been President Trump. While it is debatable whether his policies were good for the U.S. economy as a whole, they were undoubtedly good for the currency. In particular, the corporate tax rate was reduced from 35 percent to 21 percent, and there was a dramatic rollback of government regulations. Combined, this raised the after-tax return on capital and made the United States a very attractive place to invest.

Though Joseph Biden campaigned on a plan to raise the corporate tax rate to 28 percent, he is unlikely to be able to do so with a likely divided Congress. Equally, a divided Congress is unlikely to agree to large deficit spending. However, Biden will likely make extensive use of agency appointments and executive orders to restore some of the regulations unwound under President Trump. On the margin, this will dent the relative attractiveness of U.S. investment.

In addition to his explicit policies, President Trump's unpredictable behavior made it unattractive for investors to take short positions in the dollar. At any moment, Trump could issue a tweet imposing tariffs, leading to an abrupt depreciation of the target country's currency. As this unpredictability fades under a Biden presidency, so too will the reluctance to borrow or be short the U.S. currency.

In sum, while a dollar crash does not seem imminent, the primary factors which have boosted the dollar are slowly fading, making it likely that the dollar is on the cusp of an extended depreciation cycle.

Francis Browne contributed to this article. The views presented in this article are purely the opinions of the author and are not intended to constitute investment, tax, or legal advice of any nature and should not be relied on for any purpose.

ADAM S. POSEN

President, Peterson Institute for International Economics

No, but a dollar downward adjustment is underway, and likely to be sustained. As I have said for some time, the relative values of the major global currencies are determined by a least-ugly contest. What matters is not the attractiveness of the currency or underlying economy on its own terms, but how that develops compared to the alternatives. This phenomenon particularly shows up in times of crisis or disruption, as in 2008-2010 when the U.S. economy was definitely ugly, but the alternatives, particularly the euro area, got uglier faster. So the flows then were towards dollar assets, even when the crisis hit the United States hard.

Right now we are seeing the reverse on average. For the first time since 1979-1980, it is the U.S. economy that is getting uglier faster than those of the other major currencies and even alternative assets (such as gold and cyber currencies). This reflects the political dysfunction of the United States and its substantial negative effects on pandemic policy response, which are worse than those in Europe, Japan, China, and some other mid-size market economies.

In particular, over the last six months, the European Union has created a unified fiscal policy response and validated the European Central Bank's approach. Whether or not you believe this is a Hamiltonian moment for Europe [see TIE, Summer 2020], whatever estimate you had for the risk of euro area break-up and redenomination of risk must be meaningfully lower. Even with the resurgence of the pandemic at the time of writing, Europe's public health response and results are better than those of the United States, and the failure of the U.S. Congress to pass an extension of the CARES Act will reinforce this divergence in outcomes.

The various ways in which the U.S. dollar is over-weighted in international finance--including its share of official foreign exchange reserves, of cross-border lending, of trade invoicing, and of private portfolios--are likely to be reduced as a result. This is not a dollar crash. The dollar is so overweight in all of these dimensions, from 40-80 percent or more shares on various measures, when U.S. GDP is less than quarter share of the global economy and shrinking (and trade with the United States is an even smaller share of the global total). Thus, there is plenty of room for substantial downward reduction in share without a rout. And none of these aspects require there to be one dominant currency--the network benefits can accrue to a few large currencies at once.

What would make the U.S. dollar crash beyond this downward adjustment in its international financial role is domestic political breakdown. Public debt levels and even current account deficits do not matter much for a large high-income democracy in and of themselves, so long as people believe that taxes can be raised if needed. That probability is what has kept the Japanese economy afloat even as public debt levels went above 200 percent of GDP. If due to a contested election or a divided partisan Congress the United States repeatedly cannot pass budgets in 2021, that portends badly for the dollar, just as it would for any other economy.

MOHAMED A. EL-ERIAN

President, Queens' College, Cambridge University, Chief Economic Adviser, Allianz, and author, The Only Game in Town: Central Banks, Instability, and Avoiding the Next Collapse (Random House, 2016)

Two basic concepts help anchor my views on the dollar's prospects: exchange rates are relative prices rather than absolute; and it is extremely challenging to replace something with nothing.

The future of the dollar depends not only on what is happening in the United States but also what is taking place elsewhere. Viewed through this first lens, the currency will not "crash"; and it will continue to retain its standing as the world's premier reserve currency, albeit in a world subject to higher fragmentation risk.

Undoubtedly, the United States faces a host of economic challenges. Growth is slowing at a time when additional Covid-related disruption remains a real and present danger. Already, fiscal deficits and debt have ballooned, as has the Federal Reserve's balance sheet. The inequality trifecta--of income, wealth, and opportunity--has worsened. Meanwhile, domestic political divisions are likely to hinder timely and decisive economic reforms, as well as slow the country's return to multilateralism leadership and a reversal in the recent weaponization of both trade and investment policies.

Yet the United States is by no means an outlier among advanced countries. Europe is under more immediate economic, institutional, and structural pressures. This hampers the ability of the euro to consistently out-perform the dollar and assume a predominant reserve currency role.

East Asian economies (China is particular) are in a better place, though sustaining this will require significant domestic reform to lower dependence on such an uncertain and uneven global economy. In such circumstances, the authorities may well have limited enthusiasm for sharp and sustained...