The plunging US dollar has wide ramifications for Australia and the world

The value of the US dollar has plunged this year and there are forecasts of an even bigger decline in 2021. That’s not good news for Australian exporters, already battered by the intensifying tensions with China and its assault on Australian products.

Against the basket of currencies of its major trading partners the US dollar has tumbled more than 11 per cent since the severity of the pandemic and its economic implications were first appreciated by financial markets in March.

The US dollar has just had its best week since April.
The US dollar has just had its best week since April. Credit:Phil Carrick

The dollar’s traditional status as a safe haven saw its value spike in March but it very quickly went into a downward spiral.

The shockwaves from the pandemic also slammed the Australian dollar, which plunged to a low of just above US55 cents on March 19, plumbing levels last seen nearly two decades ago. Subsequently, however, the Australian dollar has soared to more than US74 cents, its highest levels in more than two years.


The Reserve Bank, having nearly exhausted its monetary policy armoury by driving the cash rate down close to zero deploying quantitative easing – buying bonds – to force longer term rates down, would be frustrated by the surge in the dollar’s value, which undermines the competitiveness and value of exports largely denominated in US dollars and acts as a deflationary force on the economy.

That makes the future of the US dollar of consequence for the Australian economy and, indeed, the global economy. Other economies, like Europe and Japan, are battling the same currency-driven tides as Australia and confronting the same inability to arrest the appreciation in their currencies which, like the Australian dollar, are touching levels last seen in early 2018.

The situation could worsen. Citi and former Morgan Stanley economist Stephen Roach have both forecast a much bigger decline in the US dollar next year – Citi a fall of up to 20 per cent and Roach by more than 30 per cent.

There is a lot of discussion among economists and currency experts about whether the US dollar weakness is temporary or structural – whether the long reign of the dollar in global currency markets and in financial transactions is, perhaps not over, but past its peak.

There are explanations for the dollar’s current weakness. In response to the turmoil in financial markets in March and the anticipated impacts on the US economy, the US Federal Reserve Board threw everything it could at the markets, including a range of unprecedented actions like making credit available to companies and buying, indirectly, corporate bonds, including high-yield bonds. It unleashed another bout of more conventional quantitative easing.

It also opened up swap lines with other central banks to avoid a global shortage of US dollars, in effect pumping dollars into the global financial system to avert a dollar shortage and a shock to the global financial system.

US Congress also rolled out a $US2.2 trillion ($3 trillion) relief package, adding to the already escalating US budget deficit and federal debt.

That flood of US dollars, an explosion in the issuance of Treasury bonds to fund the response to the pandemic and the Fed’s actions to lower US rates close to zero – below zero in real terms – combined to weaken the dollar.

The ineptitude of the Trump administration’s response to the virus and the peculiar politics of the US in an election year also impacted the dollar and continue to affect it.

Those arguing for further substantial depreciation next year and perhaps beyond are looking to a global economic next year as the vaccines roll out – which creates a global “risk-on” environment and investment dollars flowing away from the US.

They’re also, however, sceptical of the ability of the US economy to rebound as quickly and significantly as others.

The virus is still out of control in the US, the initial relief funds are drying up and have yet to be replaced by a new package and the most recent indicators suggest that after a strong rebound the US economy is trending down again as the virus continues to spread and lockdowns re-emerge.

It appears likely there won’t be a significant response to the spread of the virus and its economic effects until the Biden administration is in place and p to speed.

Longer term, however, even when the US has overcome the pandemic and its economy is more solidly on a growth footing, the impacts of the swollen budget deficits and the massive federal debt over-hang and the Fed’s new “inflation-averaging” policy means US interest rates will remain negligible for much of this decade and there will be a continuing supply of freshly-printed US dollars.

The tumbling greenback is a big problem for RBA governor Philip Lowe.
The tumbling greenback is a big problem for RBA governor Philip Lowe.Credit:Rhett Wyman

Another legacy from the last few years might well be lower holdings of US dollars in other nation’s foreign currency reserves.

The Trump administration has weaponised the dollar with its profligate (and continuing) use of the dollar’s central role in global financial transactions to impose financial sanctions on other countries and individuals that shut them out of the global financial system.

Russia, China and Iran have been subjected to a plethora of those sanctions and have scrambled – as have some of America’s traditional allies – to devise mechanisms for circumventing them.

So far those haven’t been particularly successful but Russia, and perhaps China, appear to have been quietly lowering their dollar-denominated reserves and there is keen interest outside the US, even in Europe, for alternate reserve currencies and mediums of exchange.

The disparity between the dollar’s dominance of global financial and trade activity with America’s role in global finance and trade and the global economy – it is about 15 per cent of the global economy but the dollar is used for more than 80 per cent of foreign exchange transactions – as well as China’s ambitions of displacing the US global economic leadership, will be longer term influences on the dollar’s value.

In the meantime, those economies, like Australia’s, where the coronavirus has been contained or at least is being effectively managed, have seen spikes in the value of their currencies even before the arrival of the vaccines.

In Australia’s case its exposures to China – mainly the resource sector and iron ore in particular – have boosted the appeal of the Aussie dollar despite China’s trade sanctions on coal, barley, wine, timber and beef. China appears likely to end 2020 as the only economy larger at the end of the year than at the start.

That could change if the relationship continues to deteriorate but the expected rebound in the global economy next year ought to produce a sustained “risk-on” environment and that generally sees capital flows towards Asia. The Australian dollar and the deep and liquid market for it are seen as a safe way to gain an indirect exposure to China and Asia more broadly.

Absent a complete meltdown in the relationship with China, or an unexpectedly strong and early rebound in the US economy and sooner-than-expected rise in US interest rates, the Australian dollar is likely to remain stronger for longer.

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