By Dan Steinbock
Dr Steinbock is the founder of the Difference Group and has served as a Research Director at the India, China and America Institute (USA), and as a Visiting Fellow at the Shanghai Institutes for International Studies (China) and the EU Center (Singapore).
What a difference a year makes! Last November, the US dollar hit its 13-year high. According to the US Dollar Index, which is a measure of the currency against a basket of six other major currencies, the greenback had soared to a peak of 103. By early August this year, however, the US dollar was struggling at around less than 93.
Recently, the index climbed to 93.5, after a ‘strong jobs report’ raised expectations of an interest rate hike later this year. Yet, the job gains in July were driven mainly by low-paying, part-time jobs. This will increase the Federal Reserves interest, but may not result in a rate hike unless the wage gains translate into inflation.
Post-election troubles
In the fourth quarter of 2016, when the US dollar still seemed near-invincible, it was driven by the triumphant post-election exuberance, the associated bond yields (and the Feds anticipated rate hike), and the expectations of Trumps fiscal expansion.
Yet, even during the transition, the efforts by the US intelligence communities to subdue Trumps Russia policy began to erode faith in a strong US dollar. While the Fed had to limit rate hikes and prolong the pauses between them, Trumps fiscal ambitions became constrained by the ongoing Mueller-Russia investigation. The White House is divided, and so are the Republican House and the Senate.
Since December 2016, the US dollar has failed to rise, despite three hikes by the Federal Reserve. Meanwhile, US consumer prices have plunged from 2.6% in January, to 1.6% last month.
Strengthening of the euro
Neither Trump nor the US explains everything about the dollars fall. The Dollar Index is sensitive to the fluctuations of the largest constituent currencies that comprise it, particularly the euro (58% weight). Some dollar losses could be attributed to the euros strengthening, which began with Macrons election triumph in France, which eased concerns about the EU break-up. Moreover, as the European Central Bank (ECB) gave an upbeat EU growth and inflation outlook, the euros rise continued.
However, while Chancellor Merkels expected election win in the fall will support the euro, Macrons approval rating is falling. Apart from this, German car-makers face rising challenges, while Italian elections and UK Brexit loom ahead. There are further apprehensions regarding the ECBs exit from quantitative easing, and possible rate hikes in 2018.
Trade frictions
The US dollar can recover if the White House gets its act together and the Republican lawmakers come up with some legislative success. Besides this, the Fed must execute new hikes without adverse effects.
In reality, risks continue to prevail. Instead of fostering growth, the White House is about to ignite trade friction with China regarding intellectual property rights. Trump has already alienated his European NATO partners by declaring US steel imports a ‘national security issue’. This will cause economic damage to Germany, Canada and other major steel importers in America.
If trade friction spreads from steel to other areas like aluminium and semiconductors, the world trade will take a new hit as US trade defences” will unleash waves of retaliation from Europe to Asia. Moreover, Washingtons Russia sanctions will intensify a new Cold War, which has already resulted in retaliation from Russia. For months, the EU leaders have warned Washington about such sanctions.
A wider view
In this odd status quo, it is easy to be distracted by short-term fluctuations. Yet, if one considers the past three to four decades, the evolution of the US dollar seems continuous. Since the 1970s, and the eclipse of the gold standard, three periods of dollar surges have been followed by associated periods of decline.
Despite the continued international strength of the US dollar, all these periods reflect a steady relative erosion of the dollar, from its all-time high of 165 in 1985, to a measly 120 in the early 2000s, and to 103 last fall. In the coming months, the US dollar could still prove resilient. There may be cases of uncertainty and volatility, especially if the Trump administration finds itself cornered. However, in the longer term, the US dollars recent decline is consistent with its long-standing relative erosion.
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