Is America fed up with the strong dollar? Does it matter?

26 Jan 2018 14:40|Marcin Lipka

"The USA suggests that it is breaking the quarter of a century long tradition of a strong dollar. However, it may only be short-term and limited. The US economic condition has become a strong argument for stopping the downward trend of the dollar in the near future," writes Marcin Lipka, Conotoxia Senior Analyst.

Marcin Lipka, główny analityk

"Currency Wars" or the "End of Strong Dollar Policy" were headlines that have recently appeared around the world in the financial service sector after statements, in Davos, from the US Treasury Secretary Steven Mnuchin who remarked that a weak currency is useful for the US because it helps with foreign trade. On the one hand, this statement just proves a fact, but on the other, it may suggest that the US wants to end the almost quarter of a century long tradition of a strong currency policy, despite the fact that Mnuchin withdrew from his previous statement in the interview published by "The Wall Street Journal".

Nevertheless, Mnuchin's statements have intensified the downward trend on the dollar. However, the US currency was under strong pressure from sellers, despite rapid GDP growth in the US and prospects of further rate hikes by the US central bank. Over the past few months, this has mainly been due to the fact that capital has been flowing to emerging countries, where, during a strong global economic recovery, there is a chance to gain the highest return rates with relatively limited risk.

Politics and market definitely not on the same team

"A strong currency is beneficial for our nation." "I believe that a strong dollar is in our national interest." These remarks from Robert Rubin, the US Treasury Secretary from 1995 to 1999, have been published in "Economic Policy: Theory and Practice." Since then, his predecessors have repeated this desire to take care of the dollar's strength.

Interestingly, however, the strong dollar policy had little to do with reality. At the end of the 1990s, the US dollar was indeed strong, but in the early quarters of the new millennium the US currency index (DXY) started to depreciate significantly and in 2008 it was 40% below initial levels and reached its lowest levels for 50 years.

War or just a struggle?

Almost every reference made by officials about the currency exchange rate shows that they may indicate the beginning of a "currency war". This bold expression represents a desire to weaken one's own currency in order to achieve higher competitiveness in foreign trade, for example, by stimulating one's own economy.

First of all, such stimulation is currently unnecessary, especially taking into account tax cuts in the US and higher than expected GDP growth. Moreover, the US dollar is clearly depreciating, which is automatically improving US competitiveness. Furthermore, the dependence between economies is another argument. Too rapid a downward decline of the dollar's value may reduce its importance as a global currency and generate additional financing costs, for example, paying higher interest rates when issuing Treasury bonds.

The improvement of the foreign trade balance may also be achieved by introducing customs duties. This concept, however, is subject to foreign response. Although the United States has a substantial trade deficit in goods, it is being reduced by the positive trade balance in services. In general, the USA has a surplus in trade balance with Canada, Brazil, the United Kingdom and OPEC countries. Greater fluctuations in this respect may, therefore, cause more losses than gains. This is a signal that current events are rather a minor diplomatic clash than a prediction of a trade or currency war.

Even if the dollar falls to about 3 PLN…

The dollar's weak condition is caused mainly by strong capital flows to currencies of countries with a faster GDP growth pace than the US. However, sometimes such flows end just as suddenly as they began. Nevertheless, it is possible that the current trend may bring the dollar close to the 3.00 PLN, the US economy's foundations will remain relatively strong and, together with rate hikes, should be a sufficient reason to stop selling off the dollar soon, also in relation to the zloty.

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