Aug 20, 2020 - Economy

Why the dollar matters

a flag dollar

Illustration: Sarah Grillo/Axios

The value of the dollar has sunk to its weakest level in two years and investors are warning that a prolonged slide could be in store for the U.S. currency, leading to more of the world abandoning the dollar and the U.S. losing its "exorbitant privilege."

Why it matters: The dollar's status as the world's reserve currency has been in place since the end of World War II and provides the backbone for the U.S. economy and fiscal policy.

What we're hearing: "By issuing the world’s reserve currency, the United States has acquired an 'exorbitant privilege' — it can rely upon practically unlimited demand for its debt and borrow in global markets without fearing an exchange rate shock," Karl Schamotta, chief market strategist at Cambridge Global Payments, tells Axios.

How it works: The U.S. benefits greatly from the fact that transactions of most commodities and many international purchases by countries and businesses are made in dollars, making the greenback essential for just about every nation to hold.

  • That necessity benefits the U.S. economically and politically — it allows the country to run large deficits and debts, and to exert its will on other countries.
  • Additionally, U.S. firms get easier access to capital, advantaging them over global competitors.

Losing reserve currency status would likely increase the cost of U.S. debt exponentially and could create significant inflation.

  • It would also mean a big loss of confidence in U.S. assets that could undercut the stock market and also pull down aggregate demand, leading to slower U.S. and global growth, says Joseph Trevisani, senior analyst at FXStreet.
  • "Being the world’s currency supplies confidence into the U.S., into U.S. assets and if you start removing that then where does the world turn when things go bad?"
  • "The entire world would suffer from the U.S. losing its reserve currency status."

What's happening: Adversaries like China and Russia have been looking to unseat the dollar in order to reduce the power of the U.S.

  • Recently, China and Russia have radically increased the amount of trade they conduct in euros while multiple central banks have been buying gold as a store of safe value instead of dollars.

Yes, but: While it may be on the horizon, currency traders and analysts generally agree the dollar's demise has not yet come.

  • "I don’t see anybody else out there that could carry the baton that the dollar does in terms of global influence," says Joe Manimbo, senior market analyst at Western Union Business Solutions.
  • "I don’t think there’s any currency as well placed as the dollar to carry the torch."
Data: FactSet; Chart: Axios Visuals
Data: FactSet; Chart: Axios Visuals

The state of play: While the road is long, there is also agreement that the greenback is fading.

  • "This pandemic has only exacerbated the long, slow, questionable, yet accurate ... decline of the dollar as the dominant currency," Tempus Inc. senior FX trader and strategist Juan Perez tells Axios.

The weak dollar trade is "becoming more pronounced by the day," Boris Schlossberg, managing director of BK Asset Management, wrote in a recent note to clients.

  • "The state of political disarray is clearly weighing on the buck as the failure to produce more fiscal stimulus, the clearly partisan skirmishing over mail-in voting that threaten to undermine the credibility of the election are all taking their toll on the dollar."
  • "Nothing is expressing the weak dollar sentiment better than gold which is once again above $2000."

The big picture: But a weak dollar isn't all bad, Cambridge's Schamotta says, as the global reserve currency status also "places an exorbitant burden on the U.S."

  • "By enabling consumers, businesses and the government to spend beyond their means, the country is essentially forced into running current account deficits."
  • "And by flooding markets with liquidity, the situation leads to financial instability — which keeps forcing the Fed to intervene."
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