The Future For A Stronger Dollar

Summary

• At the start of the year, it looked as if the value of the U.S. dollar would be declining as the weak U.S. economy and the growing coronavirus pandemic dominated.
• Now, the U.S. economy looks as if it may outperform many others, and it looks like the pace of vaccinations is gaining momentum so that the future looks relatively brighter.
• This looks inflationary, which would cause the dollar to decline, but consumer price inflation might not become a problem, and this seems to be making the dollar stronger.

Earlier this year, I believed that the value of the U.S. dollar was in decline and would continue to fall through the year.

As late as the end of February, I was still writing about the U.S. dollar getting weaker.

The problem was that the value of the U.S. dollar had been getting stronger since the beginning of the year. The next term trough of the dollar's value came in early January. On January 6, 2021, the U.S. Dollar Index (DXY) was at 89.42. At that time, it took $1.2324 to purchase one euro.

By the end of February, when I wrote the above article the Dollar Index had risen to 90.26 and one euro cost only $1.2168.

On Wednesday morning, March 24, the Dollar Index was at 92.57 and one euro cost only $1.1820.

Obviously, the dollar is getting stronger, not weaker as I had expected.

What is going on?

The Turnaround

Megan Greene, writing in the Financial Times, has given us a suggestion as to why the U.S. dollar is getting stronger:

Ms. Greene writes that when the "twin deficits" - the U.S. budget deficit and the U.S. current account deficit - are rising, it is usually the case that the value of the U.S. dollar will depreciate.

Instead, this time, the U.S. dollar has been strengthening.

Ms. Greene writes,

The budget deficit hit around 15 percent of GDP in 2020 and is set to balloon further this year. The current account deficit was 3.5 percent and rising in the fourth quarter of 2020."

Furthermore, with the recent $1.9 trillion stimulus plan now having passed the U.S. Congress and with another budget plan of around $3.0 trillion being constructed, more federal debt looms in the future. And the Federal Reserve is backing up everything the federal government is doing and is suggesting that it will not allow its short-term policy interest rate to rise for an extended period of time.

Ms. Greene states that "Over the long term, the twin deficits should put downward pressure on the dollar, but the very reasons they are rising will overwhelm those structural issues for now. The dollar's turnround began as the Biden administration pushed through the whole of its $1.9tn American Rescue Plan."

In addition, Ms. Green writes that the Biden administration

significantly ramped up the pace of vaccinations, from about 900,000 a day to almost 3m. Now the US economy looks set to outperform."

According to the OECD, the rescue package alone should add 3 to 4 percentage points to 2021 GDP. Wall Street economists see GDP growth of as much as 8 percent. That will mean higher sales and profits for American companies, inviting investments by foreigners, who will need dollars."

And What About Inflation?

The missing item from all this discussion is inflation. Where is inflation in this scenario?

We have seen the inflationary expectations built into the Government bond yields rise rather rapidly this year. For example, the inflationary expectations built into the yield of the 10-year U.S. Treasury note was around 2.00 percent at the beginning of this year.

Right now, these inflationary expectations have been as high as 2.45 percent. Obviously, many market participants are worried that inflation could be rising this year.

If inflation takes off, then the problem with the double deficits will become a problem. Then, the value of the U.S. dollar will get weaker. But this would be, as Ms. Greene suggests, bad for stocks, bonds, and the dollar.

But there is the argument that inflation will not get out-of-control, duplicating the experience of the recovery following the Great Recession. This seems to be the story that Fed Chair Jerome Powell is telling the U.S. Congress and the world.

And Mr. Powell seems to be in tune with the new Treasury Secretary Janet Yellen, as is evidenced from their joint testimony before the Congress.

Thus, the federal policy makers all seem to agree that the current situation will not result in a rising rate of inflation in the near future. This will be positive for the value of the dollar.

And as Ms. Greene writes,

Stronger growth and a stronger currency should boost US imports, generating demand for the rest of the world. The OECD expects the rescue package to add one-quarter to one-half a point to eurozone and Chinese GDP, and even more for Canada and Mexico. This should also serve as a useful safety valve on inflation as the US imports disinflationary pressure. "

Finally, if a higher current account deficit results for the U.S., this would be positive for other countries, especially those in Europe, who have not engaged in the fiscal activities that the U.S. has.

The Future

So, the strengthening economy, resulting from the government's economic stimulus, along with the success in the attack on the Covid-19, could result in a situation in which the U.S. dollar gets stronger in the world. This would happen if inflation stays moderate, so the future of the dollar seems to be on whether or not inflation really picks up.

This, right now, is the rationale for the rise in the value of the dollar. As readers of my articles know, I am a firm believer in what I call credit inflation, the situation in which the expansionary policy of the government gets translated into the financial circuit of the economy and not the "real" production of goods and services. That is, the government's expansionary policy gets caught up in the rise in asset prices like stocks and commodities and not in the rise in consumer prices.

This would therefore point to a rise in the value of the U.S. dollar. We shall see. Keep an eye on what happens in the foreign exchange market.