Professor of IMD business school in Switzerland: the US dollar continues to weaken and its position as a global reserve currency is hard to guarantee?

 Professor of IMD business school in Switzerland: the US dollar continues to weaken and its position as a global reserve currency is hard to guarantee?

By arturobris, Professor of finance, IMD Business School

The painting style of US stocks this year is strange: in February and March, the largest selling wave in history appeared in US stocks, and the standard & Poors 500 index dropped by more than 30%; but then, the US stock market experienced the strongest rebound in history, and reached a record high on August 21; then, institutional investors, especially pension fund investors, swept away their panic and re planned their long-term capital Production allocation. We thought there would be the biggest stock market crash in history, but it was actually a reexamination of the main risks of financial investment.

Generally speaking, for international investors, exchange rate risk, especially the weak dollar, is the biggest financial risk this year. Although novel coronavirus pneumonia is still rampant, international investors concerns about exchange rate risk have outperformed their concerns about specific companies and industries.

Consider European investors. In the first eight months of this year, the yield in the US market was about 5% (in US dollars). However, due to the sharp depreciation of the US dollar in July and August, the return on investment of European investors in the US market was only 0.5% after being converted into euro. Some even doubt whether the US dollar will lose its dominant position as the worlds reserve currency.

Trend chart of US dollar against Euro

With its position as the worlds reserve currency, the US dollar is the currency used in most international financial transactions. As a result, the United States has gained certain economic advantages, such as being able to borrow at a lower cost and having more leeway on the national balance sheet.

Why is the dollar weak?

The novel coronavirus pneumonia has caused serious losses in the United States. 2020 is a storm for the dollar.

Affected by the novel coronavirus pneumonia, the global economy has stopped abruptly, consumption and output have plummeted, and the global supply chain has been damaged and the global commodity prices have been affected. The Baltic dry bulk index, a barometer of Global trade and economic activity, fell 6% between January and may this year. This means that the prices of many commodities are also falling, as can be seen from the CRB commodity index chart below.

Global commodity CRB index for 2019-2020: the CRB index reflects the overall value of 19 World commodities, including gold, aluminum, pork, coffee and cocoa.

For example, the World Bank estimates that global oil demand has plummeted by 9.3% from 100 million barrels a day in 2019, a record low. Since oil and many other commodities are denominated in dollars, weak demand for these commodities also means a decline in demand for dollars.

Novel coronavirus pneumonia is the highest in the world because of the failure of the government to take appropriate measures to tackle the new crown pneumonia epidemic. This has hit consumer confidence, and many are beginning to believe that the economy wont recover until 2022 at the earliest. The OECD expects the US economy to fall by at least 7.3 per cent this year, even under optimistic circumstances, and by at least 8.5 per cent in the event of a second wave.

Finally, the upcoming U.S. election has accelerated the further depreciation of the dollar. The election means that there may be a presidential change, which adds uncertainty to the recovery of the U.S. economy and affects the financial market, which has always been seeking stability. Historically, stock market volatility has increased in the months leading up to the election (although volatility has been relatively stable in recent years) and investor demand for the dollar has been weakened. Meanwhile, novel coronavirus pneumonia is not being addressed by many investors, especially in health and health. Trump is worried about the new outbreak.

The depreciation of the US dollar has made us imports more expensive, thus aggravating the deterioration of the US domestic economy. The depreciation of the US dollar has also added variables to the world economy: the appreciation of other currencies has had a negative impact on export-oriented economies such as Brazil and India, and international investors have shifted their portfolios to other developed economies, especially European economies.

Long term outlook

In general, there is no need to worry about the dollars status as the worlds reserve currency. The dollar rose 17% against the euro between 2010 and 2020, so even if the dollar is weak, it is still relatively strong.

With the end of the U.S. election, the dollar is likely to rise again, and that will come sooner than expected. In my opinion, the dark moment has passed and the US dollar has risen slightly in late August, although there may be further slight depreciation in the future.

In the coming year, financial markets are expected to make only minor adjustments. As of August 21, the 12-month forward rate of the US dollar against the euro, which reflects the exchange rate of the US dollar against the euro in a years time, is only 0.7% lower than the current transaction rate, while the 24-month forward rate is 1.5% higher than the current one.

The recent move in gold prices is another sign of a better dollar. Generally speaking, the dollar is negatively correlated with the price of gold: if the dollar falls, the price of gold rises. As of mid August, the price of gold has risen by about 30% this year; in the past five years, gold has appreciated by nearly 80%, at an annual rate of 12%. In contrast, the S & P 500s annualized return over the same period was only 10%, and has fallen to 5% since the beginning of the year. However, the forward price of gold (which reflects the markets expectation of the future price of gold) is now in a downward phase. After peaking in early August, the gold price has fallen back to the level of a month ago by the end of August.

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