The most important currency in the world is roaring and the whole currency jungle is reverberating in response.
Just after three weeks following the victory of Donald Trump, the Dollar has reached high levels against a select basket of currencies. It is now 40% above its 2011 lows. The dollar was gaining momentum slowly, but the cause for the latest surge is that with the victory of Trump, the policy will shift concentration from Monetary to Fiscal.
With the recent and impending political earthquakes in the Eurozone having made the Dollar stronger against the Euro, economists are forecasting that the route on which the politics of Eurozone is headed, it will not long before the dollar comes in parity with the Euro.
On the day of Brexit, the pound had fallen 20% against the dollar. This was the largest one-day dip after the Pound wished to opt out of the European exchange rate mechanism in the 90’s. Once the Article 50 is issued formally by Britain, there will be further downside for Pound, which too is looking to come in the parity with the greenback.
The Dollar is regarded as a safe-haven of sorts. So, whenever there is an impending crisis investors shift their money either in Gold or the dollar. This too is a cause for the rise in Dollar.
The large fiscal boost proposed by Trump will lead to faster rise in inflation levels which will subsequently lead to the Federal Reserve raising their interest rates to check inflation. The Ten Year Bond yield has risen from 1.7% to 2.3% on the election night itself. Higher yields will attract investors and capital will flow in.
Currencies of emerging market economies also haven’t performed well against the greenback. Yuan is falling rapidly against the dollar, the monetary authority are trying to stop the outflow of capital from China. India has its own problems to face with and is witnessing all times low against the greenback. Other Asian currencies are trading at levels not seen since the Asian Financial Crisis.
Faster growth in the world’s largest economy is being seen as a sense of relief. The dollar was rising at such a rapid pace during the first term of Ronald Reagan, when there was a huge budgetary deficit due to high spending to boost growth, this had grown protection sentiment among his electorate. Albeit, America’s economy contributes less to the world’s GDP as compared to earlier, , but the rise in global financial and credit markets have made the Dollars position even more important.
That makes a stronger dollar more dangerous for the world and the U.S.
America’s hegemony in trade is continuously declining. The number of countries for which the U.S is the largest exporter dropped from 44 in 1994 to 32 after more than 20 years. But the Dollar is still supreme when it comes to exchange and store value, i.e., Dollar as a reserve currency.
When the dollar rises, so does cost of servicing the debts. But its direct effort stretches more than dollar borrowers. As the dollar starts to strengthen it send the cycle into reverse. As it keeps on increasing, borrowers start to save cash to serve the increasing cost of their own debt.
A strong dollar is not all good for America. The trade deficit will widen as the rise in the greenback will lead to drop in exports and rise in imports.
In 1985, the Plaza Accord was signed between, U.S.A, Japan, U.K, France and West Germany. This accord was signed to check the rise in the greenback against these currencies. With the rise in protectionism, can the strengthening greenback be the situation to ignite global coordination.
If Trump fails to implement his policies or his policies fail to show any result, then what? Who will take the torch from the ‘King’, investors may run towards the Euro, Pound (GBP) or the Yen but they themselves haven’t been performing all that well showing political and structural weaknesses in their economies. Besides these the apparent heir looks to be Yuan, China’s currency. But it being the second largest economy in terms of GDP, still does not match to the prowess of Dollar, due to lack of financial market developments, capital control and following a managed currency.
It will take a long time to find an heir and Dollar’s reign will run supreme, at least in the near future.
By Adityapal Singh Jaggi.
Image Source: Dreamstime.com
One of the articles from The Economic Transcript (December, 2016, issue).