The strength of the dollar has been a source of great concern of late, with fundamentals indicating that its rise will not stop at the already +4% YTD.
And as the Economist emphasizes in its new analysis, a stronger dollar is “dangerous”, as it raises the foundations for difficult balances, both politically and internationally. After all, with the presidential election approaching, Democrats and Republicans seem determined to boost American manufacturing, giving new impetus to the country’s currency.
It is undeniable that the world is on the brink of a difficult new period of dollar geopolitical power. This situation is made even more difficult by the fact that one currency’s strength reflects another’s weakness. By the end of 2023, the US economy was 8% larger than at the end of 2019. At the same time, the economy of Great Britain, France, Germany and Japan each grew by less than 2% by the same period. Thus, the yen is at a 34-year low against the dollar, while the euro has fallen to $1.07 from $1.10 at the start of the year.
1 to 1 parity?
Some traders are now betting that the euro-dollar will reach parity by early next year. Should Donald Trump win in November, the environment will become more complex.
A strong dollar tends to raise the price of US exports and lower the price of imports, which would widen the country’s persistent trade deficit. And that will be a blow to Trump, especially at a time when Robert Lighthizer, the architect of the anti-China tariffs during Trump’s time in the White House, wants to weaken the dollar (according to Politico). President Joe Biden has taken a more dovish stance on the US currency, but a strong dollar is complicating his manufacturing agenda.
Otherwise, a strong dollar is good for exporters who have costs in other currencies. But high US interest rates and a strong dollar are creating “imported” inflation, now exacerbated by relatively high oil prices.
In addition, companies that have borrowed in dollars face higher repayments. On April 18 Kristalina Georgieva, head of the IMF, warned of the impact of these developments on global financial stability.
Many countries have plenty of foreign exchange reserves that they could sell to shore up their currencies: Japan has 1.3 trillion; dollars, India $643 billion and South Korea $419 billion. However, any relief would be temporary. Central banks and finance ministries cannot waste their reserves on fruitless battles.
International coordination
Another option is international coordination to stop the rise of the dollar. The beginning of this happened on April 16, when the finance ministers of the US, Japan and South Korea expressed their concerns about the yen’s decline. This could be the harbinger of more intervention – in the form of joint sales of foreign exchange reserves – to prevent further weakening of the two Asian currencies.
But as much as these countries may want to be on the same side, the economy inevitably pushes them apart. Besides, the weakness of the yen and won is driven by the interest rate gap between the US and other countries. South Korea’s two-year government bonds are yielding around 3.5%, Japan’s just 0.3%, while US bonds maturing at the same time are yielding 5%. So if interest rates remain significantly higher in the US, yield-seeking investors face a simple choice – and their decisions will inevitably support the dollar.
Then there are countries with which America is least likely to do business. According to Goldman Sachs, China saw about $39 billion in foreign exchange outflows in March as investors fled the country’s sagging economy. The yuan has weakened against the dollar since the start of the year, and more rapidly since mid-March, when the dollar rose from 7.18 yuan to 7.25.
Bank of America expects it to reach 7.45 by September, when the election campaign peaks. That would put the yuan at its weakest since 2007, providing a boost to China’s government’s latest export drive. Cheap Chinese electric vehicles may get even cheaper, angering American politicians.
In this context, even staunch supporters of protectionism in the US may be willing to overlook the weak currencies of allies, at least for a while. But it is less likely for China. That raises the risk of further tariffs and sanctions, and perhaps even putting China back on the US list of currency manipulators.
As long as the US economy performs better, the dollar is likely to remain strong. And as long as American politicians see it as a cause for concern, trade tensions will rise, the Economist concludes.
Source: OT
