Sep 27th 2020

The Vise Tightens on the Dollar

by Stephen S. Roach

Stephen S. Roach, a faculty member at Yale University and former Chairman of Morgan Stanley Asia, is the author of a new book Unbalanced: The Codependency of America and China.

NEW HAVEN – The US dollar has now entered the early stages of what looks to be a sharp descent. The dollar’s real effective exchange rate (REER) fell 4.3% in the four months ending in August. The decline has been even steeper as measured by other indexes, but the REER is what matters most for trade, competitiveness, inflation, and monetary policy.

To be sure, the recent pullback only partly reverses the nearly 7% surge from February to April. During that period, the dollar benefited from the flight to safety triggered by the “sudden stop” in the global economy and world financial markets arising from the COVID-19 lockdown. Even with the recent modest correction, the greenback remains the most overvalued major currency in the world, with the REER still 34% above its July 2011 low.

I continue to expect this broad dollar index to plunge by as much as 35% by the end of 2021. This reflects three considerations: rapid deterioration in US macroeconomic imbalances, the ascendancy of the euro and the renminbi as viable alternatives, and the end of that special aura of American exceptionalism that has given the dollar Teflon-like resilience for most of the post-World War II era.

The first factor – America’s mounting imbalances – is now playing out in real time with a vengeance. The confluence of an unprecedented erosion of domestic saving and the current-account deficit – joined at the hip through arithmetic accounting identities – is nothing short of staggering.

The net national saving rate, which measures the combined depreciation-adjusted saving of businesses, households, and the government sector, plunged into negative territory at -1% in the second quarter of 2020. That had not happened since the global financial crisis of 2008-09, when net national saving fell into negative territory for nine consecutive quarters, averaging -1.7% from the second quarter of 2008 to the second quarter of 2010.

But the most important aspect of this development was the speed of the collapse. At -1% in the second quarter, the net saving rate fell fully 3.9 percentage points from the pre-COVID 2.9% reading in the first quarter. This is, by far, the sharpest one-quarter plunge in domestic saving on record, dating back to 1947.

What has triggered this unprecedented collapse in net domestic saving is no secret. COVID-19 sparked a temporary surge in personal saving that has been more than outweighed by a record expansion in the federal budget deficit. The Coronavirus Aid, Relief, and Economic Security (CARES) Act featured $1,200 relief checks to most Americans, as well as a sharp expansion of unemployment insurance benefits, both of which boosted the personal saving rate to an unheard of 33.7% in April. Absent these one-off injections, the personal saving rate quickly receded to a still-lofty 17.8% in July and is set to fall even more sharply with the recent expiration of expanded unemployment benefits.

Offsetting this was a $4.5 trillion annualized widening of the federal deficit in the second quarter of 2020 (on a net saving basis), to $5.7 trillion, which swamped the $3.1 trillion surge in net personal saving in the same period. With personal saving likely to recede sharply in the months ahead and the federal budget deficit exploding toward 16% of GDP in the current fiscal year, according to the Congressional Budget Office, the plunge in net domestic saving in the second quarter of 2020 is only a hint of what lies ahead.

This will trigger a collapse in the US current-account deficit. Lacking in saving and wanting to invest and grow, the US must import surplus saving from abroad and run massive external deficits to attract foreign capital. Again, this is not esoteric economic theory – just a simple balance-of-payments accounting identity.

The validity of this linkage was, in fact, confirmed by the recent release of US international transactions statistics for the second quarter of 2020. Reflecting the plunge in domestic saving, the current-account deficit widened to 3.5% of GDP – the worst since the 4.3% deficit in the fourth quarter of 2008 during the global financial crisis.

Like the saving collapse, the current-account dynamic is unfolding in an equally ferocious fashion. Relative to the 2.1%-of-GDP current-account deficit in the first period of 2020, the 1.4-percentage-point widening in the second quarter was the largest quarterly deterioration on record (dating back to 1960).

With the net domestic saving rate likely headed into record depths of between -5% and -10% of national income, I fully expect the current-account deficit to break its previous record of 6.3% of GDP, recorded in the fourth quarter of 2005. Driven by the explosive surge in the federal budget deficit this year and next, the collapse of domestic saving and the current-account implosion should unfold at near-lightning speed.

It is not just rapidly destabilizing saving and current-account imbalances that are putting downward pressure on the dollar. A shift in the Federal Reserve’s policy strategy is a new and important ingredient in the mix. By moving to an approach that now targets average inflation, the Fed is sending an important message: zero-interest rates are likely to persist for longer than previously thought, regardless of any temporary overshoots of the 2% price stability target.

This new bias toward monetary accommodation effectively closes off an important option – upward adjustments to interest rates – that has long tempered currency declines in most economies. By default, that puts even more pressure on the falling dollar as the escape valve from America’s rapidly deteriorating macroeconomic imbalances.

In short, the vise is tightening on a still-overvalued dollar. Domestic saving is now plunging as never before, and the current-account balance is following suit. Don’t expect the Fed, focused more on supporting equity and bond markets than on leaning against inflation, to save the day. The dollar’s decline has only just begun.

Stephen S. Roach is a faculty member at Yale University and the author of Unbalanced: The Codependency of America and China.

 


This article is brought to you by Project Syndicate that is a not for profit organization.

Project Syndicate brings original, engaging, and thought-provoking commentaries by esteemed leaders and thinkers from around the world to readers everywhere. By offering incisive perspectives on our changing world from those who are shaping its economics, politics, science, and culture, Project Syndicate has created an unrivalled venue for informed public debate. Please see: www.project-syndicate.org.

Should you want to support Project Syndicate you can do it by using the PayPal icon below. Your donation is paid to Project Syndicate in full after PayPal has deducted its transaction fee. Facts & Arts neither receives information about your donation nor a commission.

 

 

Browse articles by author

More Current Affairs

Oct 28th 2020
EXTRACT: "One thing is certain: a highly contested election would cause further damage to America’s global image as an exemplar of democracy and the rule of law, eroding its soft power. Particularly over the past four years, the country has increasingly come to be regarded as a political basket case. While hoping that the chaotic outcomes outlined above do not come to pass – polls still show a strong lead for Biden – investors should be preparing for the worst, not just on election day but in the weeks and months thereafter. "
Oct 27th 2020
EXTRACT: "China’s approach today is similar: first, insulate its citizens from a virulent pathogenic contagion with draconian public-health measures aimed at containing and mitigating the spread of the disease, and then – and only then – make judicious use of monetary and fiscal policy to reinforce the post-lockdown snapback. This is very different from the approach taken in the US, where the post-lockdown debate is more about using monetary and fiscal policies as front-line instruments of economic liberation, rather than relying on disciplined public-health measures aimed at virus containment........ This underscores the sharp contrast between China’s COVID-first strategy and the America-first approach of US President Donald Trump’s administration. In China, unlike the US, there is no political and public resistance to masks, social distancing, and aggressive testing as requisite norms of the COVID-19 era. Meanwhile, the US is in the midst of its third serious wave of infection while China continues to exercise prompt and effective control over new outbreaks. Earlier this autumn, for example, some nine million citizens in Qingdao were tested in just five days after a relatively small outbreak affecting fewer than 20 residents. By contrast, Trump wears his own experience with COVID-19 infection as some perverse badge of courage, rather than as a warning of what may lie ahead."
Oct 20th 2020
EXTRACTS: Disney has announced a significant restructuring of its media and entertainment business, boldly placing most of its growth ambitions and investments into its recently launched streaming service, Disney+…. From a corporate strategy perspective, the move is remarkable on two fronts. Firstly, the sheer velocity of this pivot for a company the size and age of Disney is, for lack of a better word, unprecedented….Let’s not forget that it was just last year that Disney held a near 40% revenue share of the US box office….. The fact that in just seven months of the pandemic breaking out, Disney decided to reinvent itself primarily around streaming speaks volumes about its expectations regarding the pandemic length. Clearly the group decided that waiting it out was no longer an option.”
Oct 10th 2020
EXTRACTS: "Strange as it is to say, but it is no longer uncommon to hear talk of insurrection, martial law, and civil war in the United States......... Apocalyptic warnings that next month’s election will descend into crisis are coming hard and fast....... While the atmosphere in the US is already alarming, it is worth considering just how bad things could become. There is ample reason to worry that an election-related conflict could devolve into atrocity crimes against black and brown civilians on US soil........ Genocide and mass atrocities have happened all too often, including in America. The question is not whether it could happen here, but whether it can be prevented."
Oct 9th 2020
EXTRACT: "Fifty years ago, Milton Friedman published an article in the New York Times that articulated what has come to be known as the Friedman doctrine: “the social responsibility of business is to increase its profits.” It was a theme he had developed in his 1962 book Capitalism and Freedom, where he argued that the “one and only” responsibility business owes to society is the pursuit of profits within the legal rules of the game. The Friedman doctrine put its stamp on our era. It legitimized the freewheeling capitalism that produced economic insecurity, fueled rising inequality, deepened regional divides, and intensified climate change and other environmental problems. Ultimately, it also led to a social and political backlash. Many large businesses have responded by engaging in – or paying lip service to – the notion of corporate social responsibility."
Oct 7th 2020
EXTRACT: "China is well on its way to becoming a cashless society. More than 600 million Chinese already use Alibaba’s Alipay and Tencent’s WeChat Pay to pay for much of what they purchase. Between them, the two companies control approximately 90% of China’s mobile payments market, which totaled some $17 trillion in 2019. A wide variety of sectors throughout China have since adopted Blockchain to pay bills, settle disputes in court and track shipments. The Chinese government understands that, via Blockchain, the issuance of its own cryptocurrency is an excellent way to track and record the movement of payments, goods and people."
Oct 6th 2020
EXTRACT: "The American Republic was founded by Protestants, and American elites were for a long time largely Protestant........But something extraordinary has happened since the republic was founded by Protestants in 1776. Five of the eight current Supreme Court justices are Catholics, and soon there may be six. The one Protestant on the court, Neil Gorsuch, was raised Catholic. (The other two justices are Jewish.) Nancy Pelosi, the speaker of the House of Representatives, is Catholic, as is the US attorney general, William Barr. And Joe Biden, who might be the next president, is Catholic, too."
Oct 5th 2020
EXTRACT: "...... the economic pain inflicted by COVID-19 is not being borne by publicly traded companies. It is falling on small businesses and individual service proprietors – from dry cleaners to restaurants to entertainment providers – that are not listed on the stock market (which leans more toward manufacturing). These smaller players simply do not have the capital needed to survive a shock of this duration and magnitude. And government programs that have helped keep them afloat for a while are beginning to lapse, raising the risk of a snowball effect in the event of a second wave."
Oct 4th 2020
EXTRACT: "Trump’s disinclination – and perhaps inability – to reach beyond his right-wing base, which is insufficient to elect him, also calls into question his political acumen, and is one of many reasons to doubt his basic intelligence (an issue on which he is quite sensitive). But one thing about the president is now clearer than ever: in order to perpetuate his hold on power, Trump is testing the constitution in unprecedented ways. "
Sep 30th 2020
EXTRACT: "With the US presidential election barely a month away, former Vice President Joe Biden and his advisers are devising his national-security policy and creating shortlists to fill the cabinet’s ranking positions in the event that he defeats President Donald Trump. But while presidential hopefuls traditionally have focused first on contenders to run the state, defense, and treasury departments, this time is different. With the intelligence community in an increasingly perilous state, Biden should choose a top spymaster before making any other personnel decisions."
Sep 29th 2020
While today's mounting global disruptions have accelerated an ongoing shift in global power dynamics, neither China's rise nor the emergence of COVID-19 can be blamed for the West's lost primacy. The United States and the United Kingdom took care of that on their own, with a complacent Europe watching it happen.
Sep 28th 2020
EXTRACT: "One thing is clear: the world cannot trust Xi’s dictatorship. The sooner we recognize this and act together, the sooner the Beijing bullies will have to behave better. The world will be safer and more prosperous for it."
Sep 27th 2020
EXTRACT: "Four years of political turmoil under Trump may well end with massive violence akin to a civil war. Trump is priming his base to act violently, and with over 390 million firearms in the hands of Americans, one can only imagine the calamitous consequences if violence is to erupt between his supporters and those who oppose him..... The Republican leadership in every state and every municipality are the prime body that can stop this potential calamity from occurring. Time is of the essence. Should the Republican Party as a whole fall short of taking a stand against Trump at this juncture, they will subject the nation to turmoil unseen since the Civil War. Not a single Republican leader will be able to claim that he or she were not warned."
Sep 27th 2020
EXTRACT: "I continue to expect this broad dollar index to plunge by as much as 35% by the end of 2021. This reflects three considerations: rapid deterioration in US macroeconomic imbalances, the ascendancy of the euro and the renminbi as viable alternatives, and the end of that special aura of American exceptionalism that has given the dollar Teflon-like resilience for most of the post-World War II era."
Sep 26th 2020
EXTRACT: "Covid-19 essentially hit the “fast forward” button on emerging trends in a variety of sectors of national economies, hastening the demise of the shopping mall, laying bare how unnecessary being physically located in commercial work spaces is, and sounding the death knell for numerous 100+ year-old brands that had failed to adapt to the blistering pace of change in the digital economy. Failure to contemplate and embrace the future is leaving carnage in its wake.......The onslaught of dramatic change that has accompanied Covid-19 reminds us that fragile systems crack when exposed to unexpected events while antifragile systems have the ability to resist shocks."
Sep 24th 2020
EXTRACT: "China’s foreign minister, Wang Yi, recently declared that aggression and expansionism have never been in the Chinese nation’s “genes.” It is almost astonishing that he managed to say it with a straight face. Aggression and expansionism obviously are not genetic traits, but they have defined President Xi Jinping’s tenure. Xi, who in some ways has taken up the expansionist mantle of Mao Zedong, is attempting to implement a modern version of the tributary system that Chinese emperors used to establish authority over vassal states: submit to the emperor, and reap the benefits of peace and trade with the empire."
Sep 16th 2020
EXTRACT: "Seventy-five years ago, the prestige of the United States and the United Kingdom could not have been higher. They had defeated imperial Japan and Nazi Germany, and they did so in the name of freedom and democracy. True, their ally, Stalin’s Soviet Union, had different ideas about these fine ideals, and did most of the fighting against Hitler’s Wehrmacht. Still, the English-speaking victors shaped the post-war order in large parts of the world. The basic principles of this order had been laid down in the Atlantic Charter, drawn up in 1941 by Winston Churchill and President Franklin D. Roosevelt on a battleship off the coast of Newfoundland."
Sep 14th 2020
EXTRACT: "After Trump’s inauguration in January of 2017, millions demonstrated their disapproval. We can expect the same, no matter how this election turns out. With both sides framing this election in “end of the world” terms; with the president calling into question the legitimacy of the vote, even before it happens; and with the president warning his supporters that they may have to take up arms to defend him – we have a recipe for disaster that may occur in the days that follow this election. This may very well be the Armageddon election of our lifetime."
Sep 8th 2020
EXTRACT: "The Huawei case is a harbinger of a world in which national security, privacy, and economics will interact in complicated ways. Global governance and multilateralism will often fail, for both good and bad reasons. The best we can expect is a regulatory patchwork, based on clear ground rules that help empower countries to pursue their core national interests without exporting their problems to others. Either we design this patchwork ourselves, or we will end up, willy-nilly, with a messy, less efficient, and more dangerous version."
Sep 7th 2020
EXTRACT: "China’s footprint in global foreign direct investment (FDI) has increased notably since the launch of the Belt and Road Initiative (BRI) in 2013. That served to bring Chinese overseas FDI closer to a level that one would expect, based on the country’s weight in the global economy. China accounted for about 12% of global cross-border mergers and acquisitions and 9% of announced greenfield FDI projects between 2013 and 2018. Chinese overseas FDI rose from $10 billion in 2005 (0.5% of Chinese GDP) to nearly $180 billion in 2017 (1.5% of GDP). Likewise, annual construction contracts awarded to Chinese companies increased from $10 billion in 2005 to more than $100 billion in 2017."