All Hail the Mighty Dollar… Or Not
Rodney Johnson | February 25, 2020 | There's always some old relative who, when you ask how he is, says, "I woke up on the right side of the grass, so I must be alright!" Kind of funny . . . the first time. Then it's just another non-reply that doesn't answer the question. If the only choice was being dead or alive, we wouldn't ask. The answer would be obvious. In the world of economic health, we've got something of the same scenario playing out, except instead of a quick reply from an aging uncle, we have currencies. Looking at valuations, the U.S. dollar is not just the strongman, but the superhero becoming stronger, while the others fade into the background. That might look like everything is going well for the U.S., but a deeper look shows that it's just a reflection of how poorly things look for others. In 2015, the IMF added the Chinese yuan to its currency basket known as Special Drawing Rights (SDRs). I fielded many calls and emails from readers wondering if that spelled the end of the U.S. dollar because it would thrust the Chinese currency onto the world stage. Hardly. As I pointed out, before anyone kicks Uncle Sam off the top of the hill, they'll have to prove their mettle by accounting for a majority of international trade settlements and currency transactions. No one is coming close, because investors don't trust them. In addition to the Chinese yuan, the main currencies that compete with the U.S. dollar, and are part of the SDRs, are the British pound Sterling, the Japanese yen, and the euro. When deciding what currency to use for transactions and in what currency to hold their reserves, businesses and governments have to weigh the risk and opportunity of each one. The Brits created turmoil when they voted to leave the European Union in 2015, and then made it worse by taking almost four years to seal the deal. The British pound took a beating over that time, dropping from $1.56 to $1.20, and currently sits around $1.30. If you had to stash a few billion dollars for a couple of weeks, a couple of months, or even a few years, would you want your currency risk to jump around like that? The Europeans also suffer from Brexit. The United Kingdom is the fifth largest economy on the planet. As it waves goodbye to the continent, it leaves a multi-billion-dollar hole in the European Union's operating budget, and potentially upends trade and capital flows. Everyone knows London is one of the financial centers of the world. Frankfurt doesn't roll off the tongue like that. And speaking of Germany, that country posted fourth-quarter GDP growth of exactly zero, dragging GDP growth across the euro zone below 1% for all of 2019. It cost $1.24 to buy a euro in early 2018. Now it costs $1.08. The Japanese yen has been a safe haven for investors since the 1980s, even as the Japanese economy has gone nowhere for almost three decades. With tremendous exports and innovation, Japan has been able to remain in the top five economies of the world, and consistently attracted capital in tough times. Today is different. Prime Minster Abe Shinzo came to power in 2012 promising to jumpstart the economy through fiscal and monetary policy, which he would pay for in later years with tax hikes. He tried to create inflation. It didn't work, but he still had to raise taxes to pay for his monetary largesse. The latest hike happened last fall and cast a chill over the economy, which the coronavirus made worse. The Chinese buy a lot of Japanese goods and account for a large percentage of tourism in Japan. With the virus spreading, the Chinese economic engine is sputtering and no one's rolling out the welcome mat for Chinese tourists. It took 105 yen to buy a U.S. dollar last fall, now it takes 111 yen to buy a buck. That's not a big move, but it's not the right direction if you're looking to protect your capital. And then there's China, the epicenter of the coronavirus and a country that was decelerating before the epidemic began. The Chinese yuan has moved back and forth between 6.20 and 7.00 per U.S. dollar over the last several years. The country manages its exchange rate, setting a trading range every day, so state officials specifically determine the valuation. With the virus bringing parts of the country to a standstill and more than 750 million people living under some level of quarantine, it's hard to see how their GDP growth remains positive this quarter. To reignite activity, the Chinese are likely to devalue their currency. But none of these arguments against other currencies tell me that the U.S. dollar is doing great, they just tell me that everyone else has more immediate issues. Which explains why the dollar keeps trading higher, and the 30-year Treasury yield just dipped below 2%, and now pays less than inflation. With U.S. GDP growth hovering around 2% while our federal deficit explodes to $1.4 trillion and our national debt climbs above $23 trillion, how long can this last? Investors around the world are looking for safety. Today they found the U.S. dollar. It's been the choice for years, but that can't last. I don't know if investors will move to a cryptocurrency, gold, another currency, or perhaps hard assets like real estate. But if we don't get our house in order they will eventually move, and then it will be our turn to deal with a falling currency. 
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