The currency markets rarely cause much excitement among financial analysts as short-term movements in the value of the world’s currencies are usually very modest – unlike what one sees in the more volatile debt and equity markets. But this sleepy market has been changing inexorably in the past few years.
The US dollar has appreciated by 40 per cent over the world’s leading currencies since it hit its low in 2011. More recently, most analysts are predicting that in a few months’ time the euro will hit par with the dollar. The election of Trump with his still opaque economic policies has made forecasting what direction the dollar will take even more difficult.
I recently scanned some exchange markets analysts to see what currency movements they are predicting. I am none the wiser after this research. This is hardly a surprise as currency movements no longer depend mainly on trade flows, but on the decisions of central bankers who today are the most effective de facto leaders that have an influence on economic growth.
The currency market is also based on the relative strengths and weaknesses of different currency zones. The US dollar is, of course, not just the currency of the US. According to The Economist, today the ‘dollar zone’, comprising America and countries whose currency is pegged to the US dollar, is estimated to encompass 60 per cent of the world population and 60 per cent of GDP. Yet the economic fundamentals that determine the value of the dollar are mostly determined in the US.
The main unknown factor remains the economic plan of Donald Trump. Many are predicting that Trump’s policy will be for more public spending on US infrastructure projects and lowering of taxes. This should stimulate economic growth in the US but also give rise to inflation. The Federal Reserve has forecast three rate rises in 2017 which should attract a massive flow of funds to the US – especially since the other major economic block, the EU, will probably keep interest rates low for much longer as economic growth in Europe remains sluggish.
My bet is that the US dollar will remain the king of currencies and the best store of value in 2017
These dynamics taken on their own may support the thesis of those who say that the US dollar is bound to strengthen in 2017. International investors have no very solid reason to sell the dollar as the other alternative major currencies – the pound sterling and the euro – face economic problems of their own.
Britain is struggling to define how it is going to achieve Brexit. The EU is plagued with impotent political leadership that in 2017 may see some of them kicked out by more maverick politicians.
Those who still harbour serious doubts on how Trump’s economic plan will work out, predict a fall in the dollar. Trump himself may not have much to gain with a strong dollar. With China continuing to keep its currency at very low levels to encourage its export-ing companies, there is more than a fair chance of increasing global protectionism as the US will make it that much more difficult for companies to export jobs to the Far East and other emerging markets.
One fact that some analysts overlook is the effect of a strengthening dollar on emerging economies. In the long stretch of exceptionally low interest rates, many emerging economies borrowed money internationally in US dollars, which they hoped they would repay with their own currency at exchange rates that seemed attractive at the time of borrowing.
When the dollar appreciates because economic conditions in the US improve and monetary policy becomes tighter, unaffordable emerging market debt could pose a real threat to the world’s financial system.
Some analysts are, in fact, predicting that the next financial crisis will come from the Far East emerging markets as the burden of servicing US dollar denominated debt becomes unbearable. A strong dollar is not good for either the US or emerging markets.
The collapse of the euro is also a possibility that can further complicate matters in the currency markets in 2017. Italy remains the sick man of Europe and any political disruption could well see a run on the euro by international investors. Matters will become even more complex if France elects a non-traditional president in the coming elections.
As politicians continue to masquerade as statesmen on the European stage the euro will continue to face an existential threat. My bet is that the US dollar will remain the king of currencies and the best store of value in 2017.
johncassarwhite@yahoo.com