To The Moon

While the price explosion in the US stock market last week looked spectacular, the fall in the dollar was equally spectacular. Now, there are always many different factors affecting currency developments, but the market tends to focus on just one of them. For the dollar, the main focus lately has been on Fed policy and related Federal Funds Rates. Europe started raising interest rates much later and also has much less room to raise rates given its structural (energy) problems. Japan has indicated that it wants to stick to its monetary policy and partly because of this, the yen is extremely cheap and the dollar is therefore expensive.

Yet it remains to be seen whether this is the only reason why the dollar has become so strong. It could also be because of the lack of liquidity caused by the Federal Reserve's tightening policy. Even in the US government bond market, this is causing liquidity problems. That means more dollars have to be repatriated from time to time. Something similar happened to the Japanese yen in the 1990s. The problems in Japan itself made the yen stronger as a lot of money returned to Japan. More recently, we also saw this ahead of the 2012 euro crisis. Given the weakness in the eurozone, $1.50 was a remarkable high for the euro. It is possible that this time too, dollar strength is more of a sign of weakness.

One reason to be more cautious with the dollar is that fewer and fewer rich people and countries around the world want to hold their money in dollars (or other western currencies). Rich Russians, among others, held their money in London, Paris, or Zurich with the idea that the rule of law was there for all. In practice, that turned out to be an illusion. These days, a Russian surname is enough to get a block on opening a bank account. Moreover, the Russian central bank's reserves have been seized. A central bank needs its reserves only in times of crisis, so it is particularly galling for Russians that they cannot access them. But what could happen to the Russian central bank could happen to any regime that is not friendly to us for a while. Other countries that do belong to our immediate friends are also starting to spread these risks in this regard. Rich Arabs and wealthy Chinese will be among the first to prefer to hold their money in Dubai or Singapore rather than London or New York. It is safer for a European to invest in Chinese government bonds than it is for a Chinese to invest in German Bunds. So on balance, this means much less demand for dollars and other western currencies over time.

Much of the money now spread across the financial markets is citizens' excess savings for their pensions. As the baby-boom generation retires, they are going to consume an increasing share of the pot. This means that, on balance, there is less left to invest. That while in countries like China, India, Nigeria, and other emerging countries, there will be much more saving and investment. It is only from those countries that it is not obvious that this money will go toward Western financial markets. In fact, for these countries, the renminbi and the rest of Asia are more obvious.

Finally, China is trying to offer an alternative to the dollar with the (digital renminbi). This is a long process but has gained momentum this year. Trade with Russia by countries like India, China, and Indonesia is no longer in dollars, but in local currencies. In early December, Xi will visit Saudi Arabia with the aim of paying more oil in renminbi to sideline the dollar. The G20 also looks like a time to discuss the too-strong dollar or too-weak yen. As cyclical developments cause the dollar to weaken, these structural arguments will gain traction.