The U.S. dollar has been the world’s dominant currency for a very long time, but Yale economist Stephen Roach sees this coming to an and with the U.S. dollar set to collapse.
Among the victims of the economic lockdown that most of the country had put into place in response to the COVID-19 pandemic is the U.S. dollar. There’s no question that the actions that the lockdown itself, and the measures that have been taken to mitigate its economic damage, have inflicted a lot damage on the dollar, at least in comparison to where it would be had we not had any of this happen.
The value of a currency is always relative to the value of another currency though, and we cannot just look at what is happening on one side, the U.S. side, and not compare it to what is going on with other currencies that we are using to value it against. If we miss paying enough attention to comparable value and try to calculate these things internally, we really won’t have the perspective that we need to come to the right conclusions about the outlook for currencies such as the U.S. dollar.
When looked at in isolation, the events of this year unfold as a nightmare for the dollar, and prior to actually seeing the horrors of all this unfold, we could not even have imagined a nightmare anywhere near this bad.
We went from an extremely strong economy to shutting a significant part of it down, where both the event itself and its response was very bearish for the dollar. A strong economy helps the dollar, a collapsing economy decimates it. High interest rates boost a currency, rock bottom ones devalue it significantly. Responsible fiscal management strengthens it, massively escalating fiscal spending weakens it.
With all these forces aligned against the dollar, with America’s economy this sick and with it expecting to take so long for it to fully recover from this self-mutilation, many may not be surprised to learn that there are some big bears out there, like Yale economist Stephen Roach, who is preparing for a genuine collapse of the dollar.
Roach sees the dollar crashing soon, not just the big drops that we have seen at other times when our economy was sick in bed, such as in 2008, but one far greater and worrisome. Roach sees the dollar giving up a massive 35% from here, due to all the bad things that are happening right now that do serve to devalue it, an incredible prediction.
At the outset of this economic crisis, talk like this had already started to pick up about how the dollar may take such a beating from this, but we pointed out at the time that these things are relative and no matter how bad the economic pandemic may become, this was a situation that extended not just within the U.S. but was instead a global economic pandemic of course, where all currencies are subject to considerable bashing.
This does not mean that the U.S. dollar won’t take more of a beating than some other currencies will, especially given the sheer amount that we have added to the national debt as a result of the response. The response from both Congress and the Fed was massively heroic and this is a type of heroism that significantly deteriorates your currency.
Roach is particularly concerned about how much debt that we have rung up lately, and it’s certainly true that this sort of thing does weigh heavy upon a currency. Roach also puts the country’s “dwindling savings” at the top of his list though, even though why this would be such a concern for the dollar is left unexplained.
All things being equal, seeing people save more rather than less contracts the economy, and seeing savings “dwindle” would be a stimulatory response which would mitigate the damage. In fact, this might be the only stimulatory response that does not come with corresponding costs that directly devalues our currency, those super low rates and especially all that spending of money we don’t have. Spending money we do have provides pure help for a currency, and certainly doesn’t deserve to be at the top of our concerns as it is with Roach’s.
It’s not the debt skyrocketing that does most of the damage from all this excess spending, it is the dilution of the currency that happens when we do too much of this. When we go so all-out to increase money supply, and there are a lot more dollars “in circulation” now, even though money supply and circulating currency are two different things altogether, we can think of them as similar for our purposes here, and imagine a printing press running day and night to print all these extra dollars that are needed to counter the economic pandemic we’re in.
Inflation Directly Devalues Currency, but Still Does It Comparatively
If we print 30% more money, then this means that each dollar we have now is going to be worth 30% less per share of GDP. When GDP goes down a lot like it is doing, and we’re printing this much more money, each dollar will have an even smaller share and therefore will be worth even less.
This is therefore a serious concern that goes beyond the impact of the way currency traders look at a country’s debt load, where the concern here is that this debt growing the way it is now, which was already growing out of control before this all started, and these concerns have certainly escalated. Directly diluting the dollar by way of artificially jacking up money supply this much causes damage to the dollar that is much more immediate and profound though, where it becomes devalued not in the future as these debts mature but right before our eyes in real time.
With all this said, this is still a relative thing, and while the United States has certainly led the way in seeking to devalue their currency, we can’t look at this in isolation and it is only the overspending compared to what is done in countries with competing currencies, with only the net difference weighing in on things. There’s also the dollar’s preferential status that needs to be accounted for, and while Roach foresees this dissipating over time, it is still a real force in spite of recent challenges.
It is therefore not unreasonable to think that the dollar will take a real hit from this, and it’s how much of a hit that becomes the question that needs to be addressed. A 35% decline in value is a very big number indeed, and not one to be thrown about lightly, without good enough reasons to think such a thing will actually happen.
We get to see this all play out on the charts though, where the currency market takes into account everything we know so far and prices that into currencies. We’re not limited to just guessing here as we see things happening that we may think should weaken the dollar a lot, but we then need to look at the market to see how it is digesting all of this to see how our concerns are playing out in the real world.
Just like individual stocks trade on exchanges, where you can buy baskets of them by buying shares in stock indexes that hold many stocks in it, you can trade the dollar in currency pairs against other currencies such as the euro and the yen, or you can buy the U.S. Dollar Index which has positions in USD against six other major currencies. Just like with stock indexes, the U.S. Dollar Index gives us a better perspective of how the dollar is performing overall against not just one major currency but against all of them.
The Dollar is Doing Just Fine, and Should Hold Up Quite Well
While we did see the dollar give up about 5% from top to bottom during the early stage of the pandemic, it not only quickly recovered but quickly rose to very high levels. It has backed off since then and sits right around the area that we started the year off at, meaning that whatever damage that we believe has been caused to the dollar has not caused it to be devalued on a net basis thus far.
Given that the worst is very likely over, with the economy opening up again, albeit more slowly than some may wish, and with the need for all this stimulus that has Roach and others so concerned now waning, we need to ask ourselves what more could come that would cause the dollar to decline all that more than where it is now, let alone collapse by the monumental amount of 35%.
This is not unlike people saying that the stock market will drop far more than it already did, while seeing it not only not drop further, but instead see it take all this pretty well, with only slight losses remaining. If the catastrophe itself doesn’t cause the crash we expect, where the great part of the damage that we’re so worried about has already occurred, we need to wonder how the recovery where we heal the damage is supposed to incite such massive damage.
Roach’s predictions therefore both conflict with the facts so far and also lack sufficient support or anything close as far as the expectations of our getting hit later with such an explosion. Roach sees China as establishing more of an advantage, but they famously keep the value of their currency down, and they have plenty of problems of their own.
Whatever further advantage that they can establish by their playing a more dominant role in the services industry that Roach foresees surely cannot be of a magnitude to cause the collapse of the dollar that would be required for Roach’s predictions to come true, or anything close.
A 35% loss in the dollar would take us all the way down to $63 from the $97 the index is now worth. This index has never gone below $71 though, a low that we set in 2008, and the circumstances in 2008 were a lot different than what we face today.
In 2008, the United States was ground zero for the economic damage that the collapse of the housing market caused, as it was the U.S. housing market that was decimated during that crisis, with U.S. lenders taking the blow. The fallout may have been worldwide, but the bomb exploded in the U.S. and the rest of the world was only subject to the ripple effects of it, given how connected world economies are these days.
It therefore stood to reason that the U.S. dollar would take a particular hit from this particular crisis, although the hit from even this was pretty modest overall. The dollar had already been in a steep decline over the previous 7 years, from 2001’s level of $117 to the $80 that we started 2007 with, before the time where this crisis even began to register on anyone’s radar. We did drop all the way down to $71 for a short while, a $9 dip compared to the $34 drop Roach is predicting, but by the time 2008 ended, with the financial crisis still happening in full force, we got back over $80 again and this crisis really didn’t provide any lasting bearishness.
We did end up seeing the U.S. Dollar Index dip to $74 in 2011, but this was after the recovery, and was therefore due to other factors. Whatever they were, we didn’t stay down there for long this time either. The most we can say about this crisis, and it was a significant one as well, is that this did increase volatility for a while but did not produce any effects on the dollar that were either that significant or enduring.
With the current situation, this involved economic warfare of a much more global nature, meaning that the collateral damage on currencies were much more spread around than back in 2008. This is why we see the dollar index flat for 2020 so far, and if it can hold its value under the extreme pressures that we have seen so far, it’s hard to imagine how anyone could see these events leading to such a historic collapse, on a scale never before seen.
There may come a time where the U.S. dollar is no longer seen as such a haven, but in spite of the challenges that the U.S. has been under, it is still seen that way and has even shown a lot of strength in the face of these massive pressures on it. That day may come, but we only need to look at the charts to tell that this isn’t today, nor will this likely happen anytime soon.
Investors looking to get in on movements in the U.S. Dollar Index don’t have to have a futures or forex account anymore, as this can be traded by way of buying shares in ETFs that track this index. Invesco is the leader with these and offer the UUP for the long side, playing the dollar index to go up in value, and the UDN, which goes up as the value of the dollar declines.
We do need to point out that currencies move so slowly that you really need to use quite a bit of leverage to make them spicy enough to make them competitive with trading other things like stocks, and while it may be nice to trade the dollar with the convenience of an ETF, this is really too tame of a trade for individual investors, and if they do want to make this sort of investment, there is no substitute for the leveraged trading that futures and forex trading provides, provided that it is used responsibly enough to not involve greater risk than with our other investments.
It’s fine to be on the fringe like Roach is, as these points of view may offer good insights to perhaps not have us embrace their extreme views but at least have them temper ours, but all views require enough merit, extreme or not. While the dollar may fall from here, there just aren’t good enough reasons to think that this fall will amount to very much, and if we ever get to the point where it will, we will see it materialize in the real world and not just in our overly active imaginations.