The dollar has been something of a “Simple Jack” trade over the past several sessions, diving after North Korea, rebounding on decent data/tax reform hope/the fact that Trump didn’t start a nuclear war/ ECB jawboning the euro lower, before reversing course again on Thursday after everyone decided to cherry-pick this from Mnuchin’s comments to CNBC:
A weaker dollar is somewhat better for U.S. trade.
Have a look at a five-day chart:
Obviously, this is all tied to a palpable sense of indeterminacy among traders who are all struggling to figure out if political turmoil in the U.S. will continue to leave Yellen hamstrung just as Draghi gets set to tip an exit strategy, or whether the ECB will now be forced to hold off in order to keep the euro from rising even further.
Simply put, it’s impossible to handicap this in the near-term because it’s all circular. There’s an absurdly self-referential character to the whole thing as outlined in detail earlier today in “Suspension Of Disbelief – Only In The Other Direction.”
So on days like Thursday, it might be useful to step back from the noise and focus on the longer-run trends if for no other reason than to keep your sanity.
De-dollarization has been a theme for years now – between the breakdown of traditional dynamics (e.g. the petrodollar) and threats from new institutions like the AIIB, there are very real questions about how secure king dollar’s crown really is. Here with an interesting take on the bigger picture is Bloomberg’s Mark Cudmore…
Here’s another reason to be structurally bearish the dollar. Thanks to its large appreciation in 2014, USD accounts for 64.5% of global FX reserves (as of end of 1Q 2017). And yet the U.S. only constitutes 24.6% of the world economy (as of end 2016) and that share is inexorably shrinking over time.
The dollar will remain the world’s reserve currency for years to come so there’s no reason for the numbers to match up or even converge. But they should see some long-term directional correlation.
Dollar’s relevance led the decline as both fell in the 2000s amid an emerging market boom that was accompanied by the theme of reserve diversification. Back then, the euro was being seriously considered as a rival global reserve currency. Then the euro debt-crisis struck and the dollar regained an unchallenged preeminence.
The narrative of economic divergence and dollar appreciation helped raise the U.S. share of the world economy in USD terms. With the global economy growing again, we can revert to the negative cycle which dominated for much of the 2000s. The U.S.’s economic supremacy is being slowly but surely eroded. That lowers the incentive for reserve managers to hold dollars. That weighs on the greenback, which then further devalues the U.S. economic proportion of the global economy. This cycle should not only continue, but it might actually accelerate at some point if another currency seriously challenges the dollar’s reserve status.
The undermining of oil markets will go some way to decreasing the relevance of the greenback. Financial and commodity markets elsewhere, particularly in Asia, are expanding at an incredible clip. Both demographics and potential growth rates suggest that trend will continue for many years to come. None of this is tradeable on a horizon of the next few months — but it should provide a backdrop framework when analyzing the dollar’s future.
So that was Cudmore out about an hour ago.
Apparently unable to contain himself, here is Cameron Crise, out just 45 minutes later:
Not so fast, my fine Fenian friend. To say that the dollar will decline as a reserve currency, you also have to provide a suggested alternative. The euro remains at 19% of allocated reserves, but its reputation as a store of value (the ultimate goal of FX reserves) has been found wanting, both as a result of the sovereign crisis and as a function of the negative interest rates offered by safe bonds. Who else is there? In terms of the size of the economy there’s China, but the country’s sovereign debt market isn’t nearly big or open enough to encourage a larger scale inflow from reserve managers. Even if it were, PBOC would probably take the other side of their flows, and recycle the proceeds mostly into dollars! The fact is, with oil prices apparently permanently lower than they were a decade ago, the US runs a smaller current account deficit…and there are fewer excess dollars to be recycled. There’s a reason that FX reserve growth has barely budged off of its recent lows.
Frankly, I’d be more convinced by an argument suggesting that the world’s reserve managers are going to hire a bunch of millennials who’ll switch their dollars into bitcoins, ethereum, and other crypto-“stores of value”.