I was asked this question by a senior professional this morning. He wanted to know my views vis-à-vis the current climate. This has also been the million $ question asked by my students. Why isn't the US$ falling when the global oil price is crashing - in fact, oil futures have collapsed below zero. In simple terms, the oil seller has to pay the oil buyer to take delivery. So why not the US$ suffer too?
For those who are old enough, there was a time when banks in Japan were charging depositors a fee to deposit money in their banks. As opposed to paying the depositors an interest for their savings: This is known as the "negative" interest rate effect. The rationale was, it cost the banks more to hold your money than at the rate they could lend (or incur to keep custody) your money to work for them. In essence, people didn't have the confidence that they will be able to retain the "value" of their money in time to come. Negative confidence = negative interest. A layman will say, discount the value of your current cash, for future spending. So why isn’t the US$ suffering the same fate?
I do not wish to cloud my piece with detailed empiricals - so this becomes light reading. In my opinion, some of the reasons why the greenback is holding steady is:
1. Markets expect the pandemic to be temporary and therefore, believe that an established currency with global appeal, will continue to be the stable tender for trade. Therefore, there is no necessity to "dump" this currency just now. The same cannot be said of every currency in the market now.
2. Markets believe the ubiquity of the US$ remains unaffected by Covid for global trade. There are just too many areas in the global arena where the US$ has become the "lingua franca" and it would be way too difficult to dislodge it now, especially when other nations' economies are all hammered. It’s become the “bar-code” of global trade. Perhaps it’s better to live with the devil we know.
3. The central banks of other countries are "buying" up the US as a measure of hedging their national bet. If their currencies fall, at least they have bought sufficient US$ when it was cheaper - so the diminution in the value of the home currency is offset by the appreciation of the US$ stock they are holding. Kind of balancing the books.
4. In times of "war" the US$ has historically been shown as holding its value. In fact, during the 2nd world war, it was the strongest currency. The Germans and Japanese were paying third-party (outside) manufacturers with the US$ so they were buying US$ while fighting the US. Even North Korea is doing the same now….well, it’s also printing US$ on the side. We are now, at "war" too. The market rewards the US$ in tough times.
5. In 2008, at the last recession, the US$ did indeed dip for a while when the markets felt that the collapse of several large US banks will bring down the US economy, and consequently, the value of the US$. However, in the current world scenario, while the natural economy of the US has taken a wallop, the remedial economy has boomed. This is interesting so I will explain further.
You see, as a result of the "pandemic", the US has announced a national economic rescue package of some US$3 trillion. That's about 60% of it's annual budget. So effectively, the government is pumping in cash into the economy to replace the cash lost as a result of businesses shutting down. When the "cash" element is replaced, there is a general theory that the additional corporate and consumer spending will meet the shortfalls in ordinary spending. It’s called the knock-on effect of money spent. I read somewhere that ONE US$ generates about US$5 or more. It’s the multiplier effect of money. This in effect, will provide an “economic belief” that the national currency will withstand the onslaught of the otherwise under-spending public. Nobody is panicking that the US$ will disappear because $3 trillion of it will be coming into the US economy. If the multiplier theory works, the US economy will see an expansion of at least US$ 15 trillion ? Good news for all. Why would anyone doubt the resilience of the US$ under this scenario. I think the world too believes in this.
6. While we see the cries from the large corporations and banks about the lost business(es), let's not forget that there are also the "essential services and goods" that have seen record sales. PPE manufacturers, grocery suppliers, health and sanitation services, IT services (Zoom etc), online marketing agencies etc - all these are creating new sales records daily. I said this before in other posts, while 90% of normal businesses will report massive losses (or significantly reduced profits), the overall contraction of the economy is likely to be far less. Ie. it's likely to be a dent in the end. So the world economy too is pretty much intact...maybe suffering a hiccup at most. Almost 60% of the world 's business is done in US$ and indeed, national reserves are also held as such. This is a very large "comfort" factor in maintaining the value of the US$. I would call this, the prosper thy neighbour syndrome.
7. In the classes I teach, I have always maintained that the US$ is a “currency of confidence”. Well, firstly it’s not supported by gold nor any basket of goods. It’s 2 (former) presidents have totally delinked any connection to benchmarking commodities/indices. Technically, Trump can print any amount of US$. But if he did so, it will have an expansionary effect and depreciate the value of the dollar. Perhaps because of the historical glamour, the petro-dollar affiliation or even the Hollywood glitter...the US$ enjoys a high degree of confidence in usage, reserve and trade. You can watch any movie (in any language too) where, if there is a ransom to be paid, the Russian kidnapper will quote the payment in US$. While China has been chipping away at the US' leadership, I have yet to come across any gangster quoting a ransom in Renminbi....maybe in 20 years? The US$ is simply the "darling" of trade....it has been for at least 100 years now. This pandemic is not about to wipe out this confidence people have in the US$. While actual figures cannot be ascertained easily, even China is reputed to hold at least 1.2 trillion in US$ debt, besides cold hard cash. A ruined US$ is BAD news for every sovereign economy in the world. It's akin to cutting off your nose to spite your face. So, even in this pandemic, governments are not "selling" their US$ stockpile. In fact, I believe, they are buying.
8. The lack of a reliable replacement. No matter how much the world believes in the EURO, Sterling, Yuan or the Yen, there simply isn't (yet) a match for the fungibility nor the ubiquity of the dollar. For this to happen, there has to a be new world order where ALL items are no longer pegged to a currency, especially the US$. Oil lost it's leadership as a currency peg when people got earth conscious and green energy became the buzzword. It's only a matter of time, the long awaited electric cars, planes, large engines and ships will go mainstream. Petrol fuelled engines will be relegated to classic and antique cars. The age of the non-regenerative fuel is coming to an end. I dare say, the millenials will see a new energy source unknown as of now. But given the advent of technology, one thing doesn't look like it will change that soon...the value of the US$. There has to be an established measure of value that the world feels comfortable with. For now, and perhaps another 10 years, it’s the US$.
9. The above being the case, will the US$ lose it's allure ? As an observer of technology trends, I believe it will. Just like the days of the "shells", "chickens", "coins" and "bank leaves" – these value carriers went out of fashion by the late 1800’s, so will paper money. I see the demise of paper money (including US$) when a new form of value recognition gains prominence, and fungibility. I do not wish to belabour the point here but I see a few Crypto currencies coming into mainstream economy. Well, they will have to first gain the acceptance of Wall Street sharks. But as we speak, there are already crypto currency whales abound. We live in exciting times. The pandemic is a little hump along the way. In the meantime, keep your US$.
Ramesh Rajaratnam views the world in unusual ways but believes, the earth will go on without human interference. The smallest of nature’s creation has the ability to paralyze the largest of mankind’s innovention.
