Bloomberg News: The Dollar's Crash Is Only Just Beginning

Article by Stephen Roach in Bloomberg News

After an initial spike higher, the dollar has been falling steadily since the Covid-19 pandemic took hold in the U.S. last March. It is down about 10% to 12% relative to America’s major trading partners, dropping to its weakest levels since early 2018 as measured by several of the broad dollar indexes. There is more to come.

Based on a wildly unpopular forecast that I made in June of a 35% decline in the value of the dollar by the end of 2021, we are only in the third inning of a nine-inning baseball game. If that forecast comes to pass, it will provide an important exclamation point on the first year in office for America’s 46th president, Joe Biden.

Getting Weaker

The dollar is trading at its lowest level against its major peers since early 2018

There were three main reasons why I argued the dollar would fall: 1) a sharp widening in the  U.S. current-account deficit, 2) the rise of the euro, and 3) a Federal Reserve that would do little in response to any weakness in the greenback. On each of these counts, I have greater conviction on the weak-dollar call today than I did six months ago. Consider the following:

The current account. As expected, the current-account deficit (the broadest measure of trade because it includes investment income) has deteriorated further, widening by 1.2 percentage points to 3.3% of gross domestic product in the second quarter of 2020 and by an additional 0.1 percentage point to 3.4% in the third quarter. The shift in the second quarter was the largest erosion on record, and at its current level the deficit is at its worst since the end of 2008.

With the pandemic and its aftershocks still very much in evidence, another $2.8 trillion of fiscal relief is in the offing — $900 billion already signed into law in December 2020 and another $1.9 trillion proposed by Biden.

The combined Covid relief packages total $5 trillion, or 24% of 2020 GDP. While not stimulus in the conventional sense, this fiscal injection breaks all modern records by a wide margin. The domestic saving rate, as a result, should plunge further below zero, putting the already wide current-account deficit under even more intense downward pressure. 

The Federal Reserve. When current-account deficits are under pressure, the central bank can usually be counted on to come to the rescue by tightening monetary policy. That, most assuredly, is not the case with today’s Fed. By adopting a new “average inflation” targeting regime in August, the Fed has sent a strong signal that it will move later rather than sooner to counter any surge in inflation rates.

 Nor can so-called Modern Monetary Theory ride to the rescue of the dollar. Yes, debt and deficits may

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