Tyranny, Liberty, B.S. And The Dollar

Dollar weakness is becoming the consensus narrative, which probably means we’re about to witness some kind of dramatic episode that drives down breakevens, pushes up reals, and sends everyone scurrying for the safety of USD cash — a March redux.

I jest. But only a little. Cast a wary eye at consensus narratives. They have a habit of going awry. And sometimes quickly. The best-laid plans, and such.

But, for now, the stars have aligned for dollar weakness, just as they’ve aligned for gold strength. I talked about this at length on multiple occasions this week, including Friday afternoon, when I described the dollar’s “perfect storm” scenario.

The US appears poised to lag the rest of the world on the recovery path as states representing more than 75% of the population have either paused or rolled back their re-opening plans. Short rates pinned at zero have eroded the rate differentials pillar for the greenback, and there are jitters about what a Biden administration might mean for capital flows. Throw in the twin deficit argument (which you can always make) and you’ve got yourself a bear case.

To be sure, everyone has loosened the fiscal purse strings in the wake of the pandemic. Everyone likewise cut rates and, where possible, ramped up asset purchases to accommodate government spending. So, it’s not that the US is doing anything on the fiscal/monetary policy fronts that everyone else isn’t doing, it’s just that because the NIRP economies can’t go much lower on rates, differentials have necessarily collapsed with the Fed’s quick retreat to the lower-bound.

Meanwhile, the US economy looks shakier by the week. Jobless claims rose for the first time since March, the latest figures show, a warning sign, as Congress dithers on new virus relief.

There are now good reasons to believe that top-tier economic data for July will betray a significant slowdown commensurate with the paused re-opening push.

“[We] forecast the trade-weighted USD will weaken by an additional 5.3% during the next 12 months”, Goldman says.

“Despite the recent selloff, the greenback remains overvalued by most metrics and offers poor fundamentals”, the bank went on to write, in a Friday note, adding that,

The Fed lowered rates to their effective lower bound and FX volatility has increased, making vol-adjusted carry in the USD relatively low on most G10 crosses. The dollar is also negatively correlated with the health of the global economy, which continues to improve much more rapidly outside of the United States than domestically. Heavy Treasury issuance in the coming years to finance the government’s fiscal response to COVID-19 and sovereigns diversifying reserve assets away from the USD are also likely to be sources of downward pressure.

The bank goes on to say that the trade-weighted USD’s decline since mid-May “ranks in the 2nd historical percentile of 2-month moves since 1973”.

“The US no longer has a yield advantage, there’s no growth advantage with the recovery from the coronavirus likely to prove more challenging than other developed markets”, one Australian portfolio manager said this week.

“The Fed has lowered rates, Europe seems to have gotten its act together on the fiscal front and the dollar is also suffering from completely dysfunctional politics in the US”, a Canadian adviser remarked.

On Thursday, I talked at length about the dollar’s trip from sharply overvalued in March, when real yields spiked and the world liquidated everything that wasn’t tied down to raise USD cash, and now, when the greenback is actually undervalued on some models (see “Dollars At A Discount – Long Live The King“). Over the longer-haul, I firmly believe de-dollarization will come about not based on “fundamentals” of any sort, but rather because the world will look to move away from a system where everyone is effectively beholden to the Fed and the vagaries of the same “completely dysfunctional politics” mentioned by the adviser quoted above (named “Stephen Miller” ironically enough).

As businesses re-close and states roll back their re-opening plans, the US recovery is poised to stall, and all of the above together means the greenback has lost pretty much every pillar of support over the past several months.

The disparity between the US’s predicament vis-à-vis COVID-19 and the rest of the world is astounding and speaks not just to profound government ineptitude, but also to America’s deeply ingrained wariness towards any kind of benign paternalism on the part of officials.

You say ‘social distance’, I shriek “liberty!” Then I go to a crowded bar. You say “wear a mask”, I assert my right to sneeze openly into the free, American air we all breathe. Then, we all get sick.

This faux crusade against the “tyranny” of mask mandates commingles with Americans’ alarming propensity to believe in conspiracies. “I think it’s a whole government crock of B.S.”, one Texas resident told Bloomberg, for a highly disturbing piece documenting the mood in rural Texas. “They want to get rid of the president”.

Again, this has its roots in the country’s history.

“[Texas] Governor Greg Abbott, who initially resisted stringent measures to combat the disease, is enduring the fury of his own party’s right wing to convince voters”, the same Bloomberg article reads. “Four Republican state legislators called mask requirements ‘tyranny, plain and simple'”.

That is “plain” absurd, but it’s not surprising. It harkens back to why it took the country so long to establish a modern civil service. “This reflects… different social structure and political values… and the fact that the US was simultaneously more democratic and more suspicious of state power”, Francis Fukuyama wrote in 2014, explaining why it took America nearly two generations to build a modern state with an effective administrative system. “The US to the present day has never succeeded in establishing the kind of high-quality state that exists in certain other rich democracies, particularly those coming out of absolutist traditions such as Germany”.

So, here we are. Killing off the recovery and ourselves, by insisting that there is some connection between a strain of viral pneumonia and “liberty” — implicitly claiming that the founders are calling, from beyond the grave, and warning us about the slippery slope from mask-wearing at Walmart to government tyranny.

More than 145,000 Americans are now conversing with the founders. If the behavior described in the linked Bloomberg piece persists, that number will keep climbing. And the dollar will keep falling, until such a time as a new lockdown pushes the world’s largest economy into an even deeper recession, at which point the world will once again look to raise USDs in a panic, the ultimate in tragicomedic outcomes.