See More on Facebook

Analysis, Opinion

Dollars and Sense

Andrew Sheng for Asia News Network.

Written by

Updated: August 5, 2019

Last Wednesday, the US Fed Chairman Jay Powell announced a cut in the Fed Funds rate by 25 basis points, citing slower global growth and muted inflation.   This was evidently insufficient to appease either the markets or President Trump, who openly asked for a ‘large cut’ just before the Federal Open Market Committee (FOMC) meeting.

After the announcement, he tweeted, “as usual, Powell let us down.”   Perhaps reflecting Trump’s sentiment, the US markets fell by 1% and the dollar actually strengthened slightly against other currencies.

How do we make sense of what is happening to the dollar, the most important reserve currency in the world?

The dollar is important, because it not only accounts for 44% of daily global foreign exchange trading and roughly 60% of total official foreign exchange reserves.   Because the dollar has a very liquid market both on-shore and offshore, companies and governments like to borrow in dollars, especially when the interest rates are low.   As the BIS reported, there are now $11 trillion in US$ debt that are booked offshore.  In addition, the US has net international investment position (debt) of $9.5 trillion or 47.4% of GDP at the end of 2018.

Noting that the US Federal budget deficit is running at over $1 trillion annually, bringing gross debt to an estimated 113.2% of GDP and net investment deficit of 51.4% of GDP by 2024, the IMF has warned bluntly that “the US public debt is on an unsustainable path.”

The same June 2019 IMF report card on the US economy (technically called the Article IV consultation report) also says:: “The US economy is in the longest expansion in recorded history. Unemployment is at levels not seen since the 1960s, real wages are rising, and inflationary pressures remain subdued.”    That doesn’t sound like an economy in trouble.

We all know what worries Mr. Trump.  If the economy, and especially the stock market, tanks in the run up to the November 2020 elections, then his re-election would be in trouble.   But why should the financial markets be worried?

The answer lies in the fact that there is a very close relationship between the stock market and central bank balance sheets.   Since 2015, when the Fed started to “normal” interest rates (by raising them) and reversing quantitative easing (expanding its balance sheets), the S&P500 stock market index has roughly topped and moved sideways.

Everything is relative.  During this period, both the European Central Bank and Bank of Japan have been easing, concerned about the slow growth of their economies.  The People’s Bank has eased to relieve liquidity during a period of deleveraging, in order not to over-tighten during a period of trade tensions.   Hence, if the world is slowing down overall faster than expected, monetary policy cannot be too tight to push the economies into recession territory.

But the US has now begun to politicize the dollar by increasing the rhetoric on currency manipulation, excessive surpluses and threats on using tariffs and sanctions on trading partners and rivals to try and contain its unsustainable trade deficits and debt trajectory.

This is because Trump and some in his Administration think that the dollar is overvalued, and wants lower interest rates to help alleviate the upward valuation pressure.

But the US Administration may be boxed in by its own asymmetric dollar trap.   The Fed is in charge of monetary policy (the main tool that affects the external price of the dollar), but responsibility for the exchange rate lies with the US Treasury.   If the Treasury ramps up sanctions, threats of currency manipulation and/or tariff increases, the major trading partners could easily negate these by either easier monetary policy or allowing their exchange rates to depreciate.

Exchange rates are by nature bilateral. Given the massive size of global foreign exchange markets, the US cannot unilaterally depreciate the US dollar without the help of concerted cooperation of major reserve currency central banks.  Today they may or may not cooperate since the US has threatened almost all of them on “unfair trade”, currency manipulation and the like.

The last time the dollar successfully depreciated through intervention was through the Plaza Accord of 1985, when Japan, Germany, France, UK and the US jointly intervened in the foreign exchange markets to depreciate the dollar.

This time round, the US would not be able to convene another Plaza Accord because Europe, Japan and China may not want to cooperate.   Indeed, fundamental disagreements over sanctions using the dollar on trading with Iran and other countries have caused the Europeans, China, India, Russia and others to consider non-dollar alternative payment mechanisms.   Furthermore, going forward, the growing trade surplus countries are more in Europe (particularly Germany and Netherlands) than in Japan or China, as the IMF External Sector Report 2019 showed.

Much will depend whether the Germans or Netherlands are willing to reflate fiscally, but based on the bad experience of the Chinese reflation in 2009, these fiscally conservative countries are likely to push the deficit countries (mainly the US) to address their structural imbalances rather than bear the costs of getting their own economies out of whack.

Even though the US has considerable “exhorbitant privileges” in enjoying the benefits of the dollar as the dominant reserve currency, in the long-run, this cannot be sustainable unless the US is willing to take tough pains to correct her structural savings deficit.   Even though Trump may want America First, the other global players will play for the long haul and wait for the US to plea for mutual cooperation and assistance.

There is no such thing as a free lunch.  The US must work within the global financial system through cooperation rather than coercion.  To go it alone, as what happened with Smoot-Hawley protectionist moves in the 1930s, risks sending the world into another global recession.

In this highly interconnected world, no country, not even the US can go it alone – for long.

Enjoyed this story? Share it.

Asia News Network
About the Author: Asia News Network is a regional media alliance comprising 24 media entities.

Eastern Briefings

All you need to know about Asia

Our Eastern Briefings Newsletter presents curated stories from 22 Asian newspapers from South, Southeast and Northeast Asia.

Sign up and stay updated with the latest news.

By providing us with your email address, you agree to our Privacy Policy and Terms of Service.

View Today's Newsletter Here

Analysis, Opinion

Why did Karachi sink in the rain?

The city’s topography has been altered without any regard to the overall form of the megapolis. As per the Meteorological Department’s near accurate prediction, Karachi experienced torrential rain this month. 27 people died and many more were injured. The situation was compounded by Eidul Azha that was being celebrated at the same time. Scores of cattle markets were set up in different locations across the city in addition to the central outlet along the Super Highway. Poor animals and their hapless keepers had to face a tough ordeal. Prices fell down sharply as animals began to fall sick due to the downpour and the filth. The rain caused a complete breakdown of urban life. Poor design and management of roads, drainage, intersections, underground sewers and sidewalks caused unparalleled chaos and

By Dawn
August 16, 2019

Analysis, Opinion

India gauges international response to its Kashmir decision

Delhi’s unilateral move has been met with varying response from the international community. India’s decided earlier this month to revoke the special status of Jammu and Kashmir state. The state will be bifurcated it into two union territories – Jammu Kashmir and Ladakh – which will be accountable directly to the federal government. Whether India likes it or not, its Kashmir decision has international ramifications and Modi’s government will be gauging them carefully. That is relatively good news for India’s Narendra Modi-led government which has staked much of its political capital on coming through on this long-promised move after winning a landslide second consecutive election in May. United States President Donald Trump said in a bland statement: “We are closely following the events in the state of Jammu and Kashmir. We take note of India’s a

By Ishan Joshi
August 15, 2019

Analysis, Opinion

Editorial: Draconian measures in Jammu & Kashmir

India must treat Kashmiris like its own citizens the way it claims and not alienate them any longer. On August 5, the world’s largest secular democracy decided to unilaterally dissolve the autonomy of its only Muslim-majority state and replace it with direct rule by the federal government. Eight days since, the goings-on in what was once Jammu and Kashmir, home to 12.5 million, remain opaque. The region is under curfew, with all communication and media cut and security forces on the streets enforcing a tight clampdown. Even as international media cover Indian-administered Kashmir to shed more light on the situation, India insist

By The Kathmandu Post
August 15, 2019

Analysis, Opinion

When Jakarta is hit by inconvenience: The capital’s grand blackout

Indonesians are waking up to far-flung grievances. The Sunday blackout on Aug. 4 in Greater Jakarta and parts of West Java was said to be the worst in many years. Family and friends’ gatherings were still cheerful but hot as houses lost their air-cons; the new pride of President Joko “Jokowi” Widodo and that of Jakartans, the MRT, seemed to blush in shame as the power back up, it turned out, was for the stations and not ready yet for the MRT itself – from which passengers had to be evacuated. Gone was all the talk of the digital revolution and the cashless world as people suddenly found they had to rummage for cash for transactions. We’re still waiting for results of an investigation into what happened following the president’s stone-faced response; so speculations range from inadequate back up, slow contingency measures to allegations of sabotage and even whether a single big tree g

By Asia News Network
August 12, 2019

Analysis, Opinion

Spy on thy neighbours

Nepal’s geostrategic position makes it the perfect place for clandestine diplomatic consultations. Located at the crossroads of Eastern and Western Europe, Vienna is still considered to be the spy capital of the world. Hong Kong has maintained its reputation of being the spy hub of East Asia. Dubai is an ideal place for investment, exchange and operations of all kinds between Central Asia, South Asia and Northern Africa. Singapore is an ideally situated city-state to partner with the

By The Kathmandu Post
August 8, 2019

Analysis, Opinion

OPINION: Bold initiative in India’s Kashmir push

Like it or loathe it, India’s government made a bold push with its Kashmir initiative. While debates on the constitutionality of the decisions announced by the Government on Monday about Jammu and Kashmir will rage for a long time, and perhaps be adjudicated in a court of law, there can be no question on the boldness of the initiative. From a historical perspective, the presence of J & K in the Indian Union was repudiation of Jinnah’s two-nation theory; however, the presence of Article 370 conferring special status on the territory contradicted, in substantial measure, this repudiation. Realising this, the constitutional provision was introduced purely as a temporary measure. Of course, it suited a confluence of vested interests ~ many in the region and the country and nearly as many outside ~ to permanently keep Kashmir in the twilight zone of constitutional ambiguity while profiting from its mise

By The Statesman
August 7, 2019