COMMENTARY
Macroscope
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As cracks appear in the dollar, it’s time now for the euro, yen and yuan to enjoy the limelight

Dollar is showing strong signs a correction has already begun. The weak euro and yen are staging good comebacks, which should lend good momentum for the yuan

PUBLISHED : Monday, 29 May, 2017, 9:41am
UPDATED : Monday, 29 May, 2017, 10:49pm

There is a golden rule among the myriad of factors driving exchange rates that what policymakers want for their currencies, they generally tend to get.

And that helps explain why China’s authorities have little chance of preventing the yuan getting a lot stronger against the US dollar in the months ahead.

Quite simply, US President Donald Trump wants a weaker dollar to boost stronger domestic growth and there is a very good chance that he will get his wish fulfilled fairly soon. The dollar has been locked into a major rally since the dark days of the global financial crisis back in 2008. It has come a long way since and now it looks ripe for a major reversal south again.

The dollar is showing strong signs that a correction has already begun in earnest. The chronically weak euro and yen are staging good comebacks, a trend that should lend good momentum for the yuan in the coming months. The dollar is going down boosting other currencies in the process. There is little China can do to stop it.

China’s central bank might try to stand in its way, invoking a new “X” factor in its efforts to stabilise yuan volatility, but it will prove fruitless in the long run. When dollar speculators get the bit between their teeth, the currency can prove unstoppable on its way up or down in major cycles.

Trump may be miscuing on many policy fronts at the moment, but he is “savvy” enough to know a good platform to jump on with respect to the dollar.

After all, it was the three-pronged policy thrust of zero US interest rates, quantitative easing and the catastrophically weak dollar back in 2008, which provided the launch pad for a strong US economic lift-off in the last 8 years.

But now, US interest rates are going up, quantitative easing will soon go into reverse and the dollar has staged a 50 per cent correction from its 2001-08 decline, all ominous precursors for future growth. If the dollar has reached a cusp it might signal the vital downward correction that US policymakers are tacitly craving.

Trump’s allies in America’s National Association of Manufacturers have probably been screaming at the president to curb the dollar’s strength.

It was just so when the association demanded former president George W. Bush put a stop to America’s strong-dollar policy back in 2001. It was hurting US exporters too much. Trump now looks set to repeat Bush’s efforts with a similar weak dollar bias.

Except it is not an “official” weak dollar policy in name, just by insinuation. Trump is simply shifting the load on to other countries by tagging their governments as “currency manipulators”.

Germany has been targeted for running a weak euro policy and similar accusations have been levelled at China in the past. It is clear what Trump wants for the currency and dollar bears simply need to read his lips for inspiration.

Dollar bears have much better reasons for downgrading the dollar than the bulls have for extending the upturn. The dollar rally looks long in the tooth and is clearly lacking in new momentum. The Trump factor is losing its appeal as over-optimistic expectations for fiscal-led stimulus fizzle out and there are deepening concerns about a future political “train crash” looming for Trump’s presidency.

Put this together with worries that the US Federal Reserve may be compromised on implementing plans for a tougher monetary policy ahead and it is no surprise markets are starting to question the inviolable belief in the dollar’s ascendency. The dollar’s bubble has finally popped.

The Trump factor is losing its appeal as over-optimistic expectations for fiscal-led stimulus fizzle out and there are deepening concerns about a future political “train crash” looming for Trump’s presidency

Don’t forget there are two sides to exchange rate plays and other currencies are beginning to look better bets right now. The euro has survived the worst that markets could throw at it in recent years and looks set for secular recovery. The yen looks well placed to pick up major safe haven flows from here too.

Certainly on relative growth and interest rate considerations, the yuan looks well placed. China continues to attract strong inward capital flows as the world’s second-largest destination for foreign direct investment. China’s rich lode of foreign currency exchange reserves is unrivalled. And, the yuan’s newfound status as a global reserve currency will continue to thrive and increase its standing.

The dollar has had its day on the upside for now and it is time for other currencies to take over and enjoy the limelight.

David Brown is chief executive of New View Economics

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