The View

Forget the trade war – it’s the strong US dollar that should really make us worry

Richard Harris says the strength of the US currency is bad news for economies with large trade deficits, budget problems or – like Turkey – enormous foreign borrowings. If the strong dollar continues, a global slowdown can’t be ruled out

PUBLISHED : Friday, 17 August, 2018, 2:00am
UPDATED : Friday, 17 August, 2018, 4:46pm

The biggest financial issue of the moment is not the collapse of the Turkish lira, or Britain’s impending ignominious exit from the European Union. Nor even Donald Trump’s tariff temper tantrums, or China’s worryingly slowing growth. It is the mighty dollar.

The United States has always taken the position of former US treasury secretary John Connally, who told European finance ministers in 1971 that the dollar “is our currency, but your problem”. The Europeans at the time were worried about a weakening dollar – this time it is the reverse. According to the Bloomberg dollar index, in four short months, the US dollar has roared up to levels not far from the peak two years ago. Before then, you would have to go back 15 years to see the dollar this strong.

Differences must be put aside to contain the crisis in Turkey

Trump’s economic policies, intentionally or not, have powered the dollar at a time when it usually cyclically weakens, even with the Federal Reserve increasing interest rates.

Trump’s tax cuts stimulated the US economy (while creating enough debt to make our grandchildren’s eyes water) and encouraged the repatriation of maybe a quarter of the US$3.5 trillion held overseas by American companies. It’s then a momentum game – the more dollars are bought, the more it goes up, and the more people will buy dollars.

Turkey has some US$467 billion of gross foreign borrowings. In Turkish lira, those debts are now worth twice what they were a year ago. A decade and a half of irrational economics under Turkish strongman President Recep Tayyip Erdogan means that the government does not have the resources for a bailout.

King Dollar means it is inevitable that Turkish companies will begin to default. This is the Greek crisis without the tough love of European support.

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Turkey is without friends and perhaps much sympathy, although Trump’s recent foolish mistake of kicking Erdogan while he was down has highlighted that country’s economic weakness to the world.

A strong dollar acts very much as the sea does when eroding rocks along the shoreline. It picks out weaknesses. Countries borrowing extensively overseas (in dollars, because lenders like it that way), who have large trading deficits or who have big domestic budgetary issues will be picked out by King Dollar traders like weak minerals in the rock.

The odds are, I estimate, about 60 per cent that this is just a temporary dollar fever, which will eventually spend itself out as the dollar gets overbought. The euro, yen and Swiss franc are not so weak as to be indefensible.

Most emerging markets, even those without stellar economic fundamentals like Indonesia and India, have plenty of monetary tools to prevent deep erosion.

Has the buoyant US economy hit the high-water mark?

Then again, we all know that a Trump tweet can be super-hawkish one day and as gentle as a dove tomorrow. A provision of more US dollar liquidity to the international markets, an easing of the tariff rhetoric, a talk down of the dollar and support of weaker countries would see the current “risk-off” sentiment turn to “risk-on” pretty sharply.

I’d give that a 30 per cent probability.

Then there is the danger that the fever takes over the whole body. Too much dollar strength for too long leads to widespread defaults and bankruptcies, uncontained by weak national economies, leading to significant damage to global economic growth.

The calling in of loans would lead to a credit crunch and dominoes of failing companies and economies – causing, as The Donald once said, “fire and fury like the world has never seen”. I’d give this risk maybe 10 per cent.

Does that mean we should take money off the investment table? Not really. There is a 90 per cent risk of things working out.

Economies are fundamentally strong, corporate earnings are fine; the world is solvent if not particularly liquid. The strong dollar is certainty a risk event and markets are likely to stall for a while – but October is traditionally black anyway.

At least we can be a little smug in Hong Kong, as we have a currency anchored to the US dollar. Our precious peg slightly shelters us from dollar fever.

As of the end of July, the official foreign currency reserve assets of the Hong Kong government amounted to nearly US$431 billion, which is over seven times the currency in circulation. Solid as a rock. At least our fathers left us a nest egg for our children.

Richard Harris is a veteran investment manager, banker, writer and broadcaster and financial expert witness.