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Donald Trump is interested in the falling dollar (Photo: flickr.com/gageskidmore)
Will the dollar retain its reserve currency status amid the US economy slump? And why the devaluation of the dollar is hampering EU exporters. Read more in the RBK-Ukraine material.
The United States is possibly the country most affected by the coronavirus pandemic. And it is not just about the record morbidity and mortality figures due to covid. The country’s economy collapsed by 9.5% in the second quarter and by approximately 32% when measured on an annualized basis. Fitch Ratings analysts expect a 4.4% drop by the end of the year.
American savings decreased, unemployment increased, and with it the federal budget deficit. The White House continues to spend billions supporting businesses and citizens without income. In fiscal year 2020 (as of October in the United States), the deficit will reach a record $ 3.7 trillion.
The depressing state of the economy could not help but affect the position of the dollar. The dollar index against world currencies (euro, yen, British pound, Canadian dollar, Swedish krona and Swiss franc) was literally in fever in the first months of strict quarantine and, since May, prices began to fall. Since the index’s peak in March (in fact, since the beginning of the “lockdown”) and to date, it has fallen almost 10%.
However, the index (USDX) has not yet gone beyond the corridor it has been in since 2016, the head of the analytical department at investment firm Eavex Capital, Dmitry Churin, drew attention. And until key support and resistance lines on the index chart are “broken,” until then it is premature to talk about continued trends in the dollar’s devaluation, the analyst said.
The fact that the cycle of a strong dollar is ending, according to UCI group trader Vitaly Sivach, is indicated by the problems and imbalances that have emerged in the US economy, and which have been further strengthened by the quarantine. Furthermore, political uncertainty is increasing in light of the upcoming presidential elections scheduled for November.
“It is not clear how to solve these problems. And, apparently, the US economy will no longer be the locomotive that it was in recent years. Investments accumulated during this time will leave the country. This will put pressure on the dollar and weaken it.” , – argues Sivach.
In the last five years, the dollar has grown, mainly because US technology companies have attracted investment from around the world, the expert explained. The influx of money made the dollar rise, as did the profits of these companies. Additionally, the high interest rate on the dollar compared to other currencies supported investor interest in US government debt.
“In Japan and Europe, for example, rates have been zero for a long time or are approaching zero. US Treasuries were of interest to investors, these values averaged 2%. They served as a kind of insurance for the investor, for example, when the markets felt bad. At this moment the US bonds were rising in price, the dollar was growing. Now the rate has dropped and it no longer works, “explained Vitaly Sivach.
Furthermore, investor confidence in the dollar is now undermined by the increase in the US double deficit. We are talking about the fiscal (budget) deficit, which grows due to the additional social spending related to the pandemic, as well as the current account deficit, since the United States imports much more than it exports. In reality, this is the key reason why President Donald Trump engaged in a trade war with China, limiting Beijing’s exports to the United States and increasingly introducing tariffs on Chinese goods.
“The double deficit undermines investor confidence in the currency. The dollar, of course, remains and will likely remain a reserve currency for a long time. But due to the low Fed rate and double deficits, this state it has been somewhat shaken “, assures the UCI trader.
It is increasingly difficult for the dollar to maintain world leadership, in the long term, said Vitaly Shapran, a member of the NBU Board. First, according to him, this is influenced by the growth of emerging markets. But the “long term” is not 20 to 30 years, Shapran believes. “So far, we only see the opportunistic reaction of investors, who, in fact, have nowhere to run except to the gold market,” said the expert.
Who will benefit from a weak dollar?
For the US economy, the weakening of its currency is a positive factor, especially amid the trade confrontation with China, said Dmitry Churin. “A weaker dollar will help the competitiveness of US products in global markets,” he explained.
What does that mean? If the United States further devalues the dollar, its current account deficit will decrease. US imports will decrease and US exports will increase. That is why a weak dollar benefits the United States.
By the way, Trump has repeatedly hinted at it even before the pandemic. In July last year, Bloomberg, citing his sources, wrote that the president was concerned about the strengthening of the dollar and asked advisers to think of options to weaken it. In public, he explained that the prospect of having a strong dollar in general is encouraging, but complicates foreign trade.
Now, a weak dollar is beneficial for the United States, because the population generally does not feel fluctuations in the exchange rate, and American exports to the EU and Asia are becoming more affordable, confirms Vitaly Shapran.
“The current weakening of the dollar could affect the demand for American products around the world, which tend to be technologically advanced. But I don’t think other countries will tolerate this state of affairs, especially those whose economies depend on exports. So it is very It is possible that in 2020-2021 we will see a currency change not only in the dollar-euro and dollar-pound markets, but also in the currency markets of developing countries, “suggested a member of the NBU Board.
Photo: Vitaliy Nosach, RBK-Ukraine
In addition, according to the expert, a strong increase in foreign currencies against the dollar, for example, the euro itself, will sooner or later raise questions on the part of exporters from these countries. “The EU economy is going through difficult times, and a strong euro could well affect German exports both to the United States and to those markets that are traditionally pegged to the US dollar,” Shapran added.
And that is why, according to the expert, the policy of a weak dollar should not be perceived as the weakness of the United States. “Here it is rather the opposite: Americans set the tone and even dictate the conditions for the dynamics of economic development for most countries that depend on foreign trade,” he explained.
At the same time, as Vitaly Sivach pointed out, a weak dollar will benefit the United States only up to a point. If uncontrolled depreciation occurs, this can have the opposite effect and greatly accelerate inflation, conventionally, up to 5-7%.
“Uncontrolled inflation will have to slow down somehow. This can be done by raising the FRS rate, which will lead to a drop in the stock market and a slowdown in the economy,” says Sivach.
If we talk about other countries that benefit from the devaluation of the dollar, they are mainly those that trade in raw materials. In fact, when the dollar falls, the cost of most commodities rises. Therefore, natural resource exporting countries can expect an increase in foreign exchange inflows from foreign markets, explains Dmitry Churin of Eavex Capital.
“Most oil-exporting countries could benefit from a weak dollar. Also Australia, which is a large exporter of iron ore and coal, looks like a winner on a weak US dollar,” Churin explains.
In this scenario, the inflow of dollars will also increase to Ukraine, which exports iron ore and cereals. And this, according to Vitaly Sivach, can be a boost for the country’s development.
Furthermore, as the interlocutor pointed out, developing countries have debts, as a rule, in dollars. And therefore, if the dollar becomes cheaper, the debt decreases. “In this case, developing countries can attract more loans and thus grow more,” says Sivach.
What to do in Ukraine
Is it worth getting out of dollar assets and looking for an alternative? For Ukraine, not everything is clear. As Dmitry Churin pointed out, the main public debt in foreign currency is denominated in US dollars, therefore, for the NBU, changing the structure of gold and foreign exchange reserves can be a risky strategy.
“The properties of any financial market involve a cyclical movement of asset values, respectively, an attempt to” keep up “with one or the other trend can lead to an unfavorable result. For funds that are reserve funds, they are should apply a conservative strategy in the long term review of the structure of selected assets ”, – explained the expert.
In his opinion, indicative is the fact that in recent years the Ministry of Finance has made several issues of Eurobonds denominated in euros. And it did just at a time when the euro was low against the US dollar.
“At the time, the rates of return on loans in euros were slightly lower than in US dollars. But given that the euro has strengthened significantly in recent years, servicing and further redemption of these Eurobonds seems more expensive than if they were originally issued in US dollars, “Churin said.
Фото: flickr.com/National Bank of Ukraine
Vitaly Shapran does not exclude that other countries change the structure of reserves against the dollar. But, in his view, this will be a short-term effect triggered by the desire to diversify further amid growing uncertainty.
“The US economy is only getting stronger with devaluation, and the strong currencies of US trading partner countries make central banks and governments of these countries think of additional incentives for exports, and given that the range of such Stimulating instruments is usually limited, I think most will be frozen in anticipation of a currency exchange in the market and retaliatory measures, “added a member of the National Council of Banks.
There is already a trend in which central banks are converting part of their reserves into gold, says ICU’s Vitaly Sivach. And, in his opinion, this is what the National Bank can pay attention to. “This will create a kind of safety cushion in case other currencies also lose value,” says the expert.
To hedge against possible inflation, according to Sivach, investors can augment portfolios of gold, silver, and even cryptocurrencies. In addition, the demand for shares of gold mining companies and manufacturers of exchange raw materials may grow.
