A crash in the dollar is likely and it could fall by as much as 35 percent by the end of 2021.”
So writes Stephen Roach of Yale University and the former Morgan Stanley Asia chair, in the Financial Times. What is going on?
To Mr. Roach, the past is catching up with the United States, the present is observing the potential for a financial collapse, and the future will be left with the job of reconstructing a new world. Where is Mr. Roach coming from?
Where Is The Federal Reserve?
The Federal Reserve seems to have taken itself out of the picture with its new approach to inflation and its interest rate policy.
As Mr. Roach writes,
The Federal Reserve has recently shifted to a strategy that takes into account an average of inflation rather than a specific target, and promised to keep policy rates near zero for several more years. That means the interest rate channel has effectively been closed.”
Furthermore, as I have written many times over the past twelve months or so, the world seems to have lost confidence in the U. S. federal government and this has added to an already substantial movement out of the “risk averse” foreign money that had flocked to the dollar before.
This lost of confidence has been accelerated at the government’s budget seems to be “out-of-control” with no end is sight to the build up
Debt is accelerating everywhere… this is happening both inside and outside the federal government. And, slower (economic) growth makes it harder for the government to reduce the debt burden.
It also makes it harder for corporations and other business enterprises to cover cash outflows, thereby threatening their ability to cover debt payments.”
Furthermore, whoever wins the election on November 3, 2020, the fiscal problems are going to be massive.
I had been predicting a falling dollar:
I still believe that the future of the dollar is further weakness. The next three months the value of the dollar will be subject to substantial volatility, but the general trend will be more decline. And, to me, there is little or nothing that policy makers can really do to stop the fall.”
But, the scenario drawn up by Mr. Roach is so much more severe. And if such a crash were to happen, it could be the added weight that results in the “solvency” crisis that will bring the post-World War II financial world to an end.
To Mr. Roach, there has been a major change in the world. Note the change in U. S. domestic savings. The “immediate source of the problem” is the deficit of the federal government. And, as I have discussed above, the deficit issue is not going to go away, but is going to increase.
Net savings dropped into negative territory in the second quarter of 2020. This was the steepest quarterly fall on records going back to 1947.
The current account deficit has also fallen (see chart below), producing the sharpest quarterly decline on record.
Both of these factors mean that the government is going to have to rely on foreign lenders to support the debt demands of the coming years. This is when Mr. Roach sees the possibility that the dollar will lose “its special privilege.”
With America’s position as the world’s dominant reserve currency, slowly eroding since 2000, foreign lenders are likely to demand concessions on the terms for such massive external financing.”
But, this is where the recent Fed actions and the loss in world confidence is going to play its role. There is no room for the U. S. government to maneuver.
Here Mr. Sloan addresses the reality of the situation. The dollar is overvalued…and by a lot!
Despite the recent decline in the dollar’s value,
a broad index of the dollar’s real effective exchange rate remains some 27 percent above its July 2011 low.
That leaves the greenback as the world’s most overvalued major currency.”
There is certainly something for investors to think about here.
The End Of The Reign Of Credit Inflation
My post of August 10, 2020 examined whether or not the age of credit inflation was coming to an end. Credit inflation, as I describe it in this post, began in the Kennedy years in the 1960s and has proceeded up to the present time. It set the grounds for continued economic expansion and low rates of unemployment. But, it also resulted in the buildup of lots and lots of debt…both in the private sector and in the public.
Rucchir Sharma, Chief Global Strategist and head of the Emerging Markets Equity at Morgan Stanley, and I agree.
The world economy went into this pandemic vulnerable to another financial crisis precisely because it had already become so fragile, so heavily dependent on constant government help. Governments have offered increasingly easy credit and generous bailouts not only to soften the impact of every crisis since the 1980s but also to try to boost growth during the good times.”
Watch what happens to the dollar in the coming months. There may be very little the government can do to prevent the fall.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.