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Weaponising the mighty dollar

Is the greenback really too strong?
October 8, 2019

A long time ago the US dollar was linked to the US Treasury’s gold reserves. The link came under increasing strain as inflation bit and demand for the precious metal was too much. So, on 15 August 1971 President Richard Nixon closed the gold window, severing the peg and ushering in the era of floating exchange rates. Due to a rather wobbly start to fiat money, in 1976 International Monetary Fund (IMF) member countries signed a deal ensuring “the exchange rate should be economically justified. Countries should avoid manipulating exchange rates in order to avoid the need to regulate the balance of payments or gain an unfair competitive advantage”.

Decades later, with a far bigger pool of floating, semi-floating and non-deliverable forward currencies with which to speculate, on 6 August this year President Donald Trump said China was a “currency manipulator”. He’s the latest in a long list of statesmen complaining about unfair trade practices. Probably the most successful foreign exchange intervention was the Plaza Accord of September 1985 when US Treasury Secretary James Baker agreed in New York with the other G5 representatives (France, Germany, the UK and Japan) that to sort America’s ballooning trade deficit the greenback would be devalued by at least 10 per cent. Then the deficit was 2.9 per cent of gross domestic product (GDP) and about $100bn; in 2018 it was 2.4 per cent of GDP and $621bn, while the record was 6 per cent and $762bn in 2006.

This calendar year the US dollar index is up just over 2 per cent – unimpressive – but has gained against all the currencies I watch except against the Russian rouble, Thai baht, Indonesian rupiah and Israeli shekel. Not the usual suspects, I think you’ll agree. The bigger problem is the strong rally the index managed in 2014 and 2015 coupled with the slower rally starting in 2018, which put it close to its higher levels of the past 30 years. This is not exactly where you want to be when embarking on a trade war with the world’s biggest exporter and second-biggest economy.

The Australian dollar has been on an incredibly steady downward trajectory for almost two years, moving neatly inside an Andrews pitchfork. At US$0.6750 it’s towards the weaker levels of the past 30 years – an inverse and obvious move against the greenback – helped along by a record low cash rate from the Reserve Bank of Australia. Not quite as cheap as it was at the height of the 2008 financial crisis, but not far off. Watch for signs of a reversal in its fortunes.

In my view, the euro is a flawed construct, so therefore I’m not surprised that against the US dollar it’s trading just over one standard deviation below its mean regression. Not nearly as cheap as the record low (US$0.8225 in October 2000), it looks as though it’ll drift towards US$1.0300 to $1.0500, the lows of the past five years.

The Russian rouble is tricky, a cross between an emerging market currency subject to sudden bouts of devaluation, a petro-currency which is steady or strengthens when energy prices are high, and an important trading unit for some. This year’s gains are between 10 per cent and a current 6 per cent; enough, but not too much, reflecting what has been a fairly subdued financial sector.