The recent dollar rally amidst the US experiencing high inflation has been perplexing market participants with the only explanation being the dollar’s safe haven status. As Ruchir Sharma argues in this article, some of this is a result of investors taking risk off the table given the current market volatility and parking themselves in cash i.e, USD and hence this seems temporary as it unwinds when risk assets come back in favour. But in this piece, Sharma makes a more structural case for a weaker dollar.
“Adjusted for inflation or not, the value of the dollar against other major currencies is now 20 per cent above its long-term trend, and above the peak reached in 2001. Since the 1970s, the typical upswing in a dollar cycle has lasted about seven years; the current upswing is in its 11th year.”
But he points to more fundamental reasons for a potentially weaker dollar. First, US’ trade imbalance: “When a current account deficit runs persistently above 5 per cent of gross domestic product, it is a reliable signal of financial trouble to come. That is most true in developed countries, where these episodes are rare, and concentrated in crisis-prone nations such as Spain, Portugal and Ireland. The US current account deficit is now close to that 5 per cent threshold, which it has broken only once since 1960. That was during the dollar’s downswing after 2001.”
Second, the US’ external debt: “Nations see their currencies weaken when the rest of the world no longer trusts that they can pay their bills. The US currently owes the world a net $18tn, or 73 per cent of US GDP, far beyond the 50 per cent threshold that has often foretold past currency crises.”
Finally, its competitive strength relative to other currencies: “The dollar has been bolstered by the weaknesses of its rivals. The euro has been repeatedly undermined by financial crises, while the renminbi is heavily managed by an authoritarian regime. Nonetheless, alternatives are gaining ground. Beyond the Big Four currencies — of the US, Europe, Japan and the UK — lies the category of “other currencies” that includes the Canadian and Australian dollar, the Swiss franc and the renminbi. They now account for 10 per cent of global reserves, up from 2 per cent in 2001. Their gains, which accelerated during the pandemic, have come mainly at the expense of the US dollar. The dollar share of foreign exchange reserves is currently at 59 per cent — the lowest since 1995. Digital currencies may look battered now, but they remain a long-run alternative as well. Meanwhile, the impact of US sanctions on Russia is demonstrating how much influence the US wields over a dollar-driven world, inspiring many countries to speed up their search for options. It’s possible that the next step is not towards a single reserve currency, but to currency blocs. South-east Asia’s largest economies are increasingly settling payments to one another directly, avoiding the dollar. Malaysia and Singapore are among the countries making similar arrangements with China, which is also extending offers of renminbi support to nations in financial distress. Central banks from Asia to the Middle East are setting up bilateral currency swap lines, also with the intention of reducing dependence on the dollar.”Ruchir Sharma

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