However, the dilemma facing European policymakers is one confronting much of the world as it struggles to recover from the destructive impact of the pandemic on economic growth.
Since March and the Fed’s decision not only to provide a deluge of dollars for its own economy through massive and open-ended purchases of bonds and other securities but to provide liquidity swaps with 14 central banks – supplying them with US dollars – the world has been drowning in US dollars.
The combination of the access to dollars, the extent of the monetary policy stimulus in the US and the Fed’s recent decision to hold US rates at their current negligible levels – negative in real terms – has seen the US dollar depreciate about 9.3 per cent against the basket of its major trading partners’ currencies since March 19. That’s its weakest level for more than two years.
A weak dollar exports deflation elsewhere. It helps US exporters be more competitive (albeit while harming importers in an economy with a structural trade deficit) and therefore one that imports more than it exports) while damaging the exports and growth prospects of economies elsewhere.
The tumbling value of the dollar has had varying impacts. At one extreme is the Australian dollar, which has appreciated almost 27 per cent from its March lows. At the other are countries such as Brazil and Turkey, whose economies have been weakened more than most by the impact of the pandemic.
Their currencies have weakened despite the weaker US dollar.
Lesser developed, emerging economies would normally be expected to benefit from dollar weakness as their own currencies strengthened by lowering the cost of mainly US dollar-denominated debt, encouraging capital inflows and lowering input costs. Concerns about their ability to fight the coronavirus and fund their responses to it have clearly weighed on their exchange rates.
Exchange rates tend to be driven by growth rate and interest rate differentials. Those are at play in the current dollar weakness, along with some less conventional influences.
When the Fed announced recently that it would change its inflation-targeting framework, in effect signalling that US rates would remain lower – in real terms negative – for much longer than markets might have been factoring in they locked in the US side of rate comparisons for the foreseeable future.
Where, for much of the post-financial crisis period, US rates were higher than those in, say, Europe, there is now no material difference. The swap lines the Fed put in place with other central banks means there is no shortage of dollars, reducing the incentive to acquire US assets. America’s bungling of its response to the pandemic – and the continued dysfunction of its fragmented response – weighs on its growth prospects.
Moreover, recent events and the looming US election – with very different policy frameworks depending on whether Donald Trump or Joe Biden emerges with the presidency – adds a sense of political instability and another layer of uncertainty to the outlook for the US.
The eurozone’s caution in responding to the strengthening of the euro – and that of other developed economies experiencing the same revaluations even as the pandemic spreads global recession – owes something to nervousness about how the Trump administration might respond if they were seen to be overtly attempting to weaken their currencies against the US dollar.
The administration’s willingness to deploy tariffs and financial sanctions and its elevation of trade as a key component of its re-election platform makes currency relativities an especially sensitive issue in the lead up to the US election.
China has allowed its currency to drift up nearly 4 per cent against the US dollar since March, although that properly reflects the extent to which its economy has rebounded relative to the continuing weakness of the US economy.
It would be even more aware than western economies of the risks of inflaming the administration, given that it is already weighed down by US tariffs and, more recently, a recent raft of financial sanctions and other measures, albeit those are targeted at companies and individuals rather than economy-wide.
There are analysts who think the decline in the value of the US dollar is structural rather than cyclical and that Trump’s abuse of the dollar’s privilege as the world’s reserve currency – use of that privilege as an option of first resort to sanction individuals and companies – will hasten that decline and the world’s search for alternatives.
Whether that’s China’s currency, which it is promoting aggressively as an international medium of exchange in competition with the dollar, albeit with only limited success, the euro or a global cryptocurrency (as espoused by former governor of the Bank of England, Mark Carney) the administration’s policies are providing incentives for eroding the dollar’s clout.
The euro is probably best-placed to challenge the dollar’s dominance, particularly after the historic decision earlier this year to allow the European Union to issue collective debt, a European alternative to US Treasury bonds.
In the near term the dollar’s position is unlikely to be directly challenged, but longer term the capacity for its reserve currency status to be used as the Trump administration has used it and America’s retreat from globalisation and the post-war global institutions that have underpinned that process may continue to chip away at that status.
Stephen is one of Australia’s most respected business journalists. He was most recently co-founder and associate editor of the Business Spectator website and an associate editor and senior columnist at The Australian.