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Has the Dollar Started Its Long Decline?

28 August 2020

Jim O'Neill

Chair, Chatham House
Ultimately, the dollar’s dominance cannot persistently outweigh the relative decline of the US economy in the world. At some point, it will start to be replaced by something else. But don’t confuse that with where the dollar’s price is heading against other currencies.

2020-08-28-us-dollar-oneill.jpg

A statue of George Washington is pictured in front of the New York Stock Exchange (NYSE) on 16 March 2020, at Wall Street in New York City. Photo by JOHANNES EISELE/AFP via Getty Images.

One of the features of financial markets since early summer has been a decline in the value of the dollar against many currencies, and with it, an especially interesting acceleration in the price of gold. In addition to the usual professional market analysis about the dollar’s movement, this has led to speculation that it might be the beginning of the end of the dollar’s pre-eminence.

Having spent far too much of my professional life as a supposed currency expert, I reiterate something I learnt early on: the foreign exchange business sometimes grants an analyst their 15 minutes of fame, but no expert is a match for the millions who participate in this huge global market all day long. But I spent over 30 years in the financial markets, the vast majority in the hubbub of the forex market. And along the journey, I think I learnt a few tricks of the trade.

At the core of trying to answer questions about the dollar, I learnt a long time ago that there are two entirely separate questions, one of which has two subsections, about the dollar. Firstly, there is the question about the use of the dollar. Will it continue to dominate the world’s financial system as the most widely accepted medium of exchange?

This is not at all the same issue as the dollar’s day-to-day performance against other currencies. This is the second question, which is almost definitely the most pertinent one to what has happened during the summer. How the dollar’s value moves against other currencies is driven by a structural, or a valuation component, and a cyclical component. Each can be analysed separately, and if you were daft enough to devote the years I did to the process, you can combine the two, to have a dynamically adjusted fair value, persuading yourself at least that such an approach combines all available information at any point in time.

In terms of valuation, the most common approach is so-called purchasing power parity, which holds that a currency, in equilibrium, will ultimately reflect the difference in prices between two countries. If inflation is persistently higher in the US than in the eurozone, then the equilibrium value of the dollar will decline over time. I developed my own version of equilibrium currency rates, as it seemed to me in the real world, that the real inflation adjusted value of a currency was not stable, and that it moved over time. This was a reflection of productivity differentials between two countries. I christened it GSDEER: 'the Goldman Sachs Dynamic Equilibrium Real Exchange Rate' when I joined the firm in 1995.

What I learned is that when a currency is more than two standard deviations away from its fair value, it makes a huge amount of sense to watch closely, and when the momentum changes, it is worth going with this trend reversal. The momentum can change based on a change in the forces that have driven the currency away from its fair value, although it can be often easier to detect simply by watching the change in price.

One of the things that has frustrated currency participants over the past decade, with the exception of the Swiss franc and the pound, is that other major currencies have not been that far away from their fair value against the dollar or each other. Even during the dollar’s rise in recent years, including the period up to the summer, while it had clearly become overvalued, with the possible exception of the pound, it hadn’t become more than two standard deviations above its own fair value. In this regard, I have believed that one might be on the lookout for a chance to buy the pound against the dollar, and perhaps against the yen.

The cyclical component of a currency’s movement around its conceptual equilibrium can perhaps best be captured in the nominal interest rate adjusted for inflation expectations. I persuaded myself that the actual spot exchange rate of the dollar on any one day should be close to the adjusted GSDEER, and if it was not, then it would be useful for traders.

The dollar had become more interesting pre-COVID, as it appeared to have risen notably against many currencies, including the euro. And in this regard, the dollar was highly susceptible, and has turned out to be actually vulnerable, to a change in the state of the US and euro area economies. Now that the Federal Reserve has returned to extremely expansive monetary policy, and with it, lower real interest rates, a dollar decline seemed pretty inevitable.

At current prices, on 26 August, the dollar still seems modestly expensive compared to dynamically adjusted fair value. The dollar decline could persist. In the late 1980s and mid 1990s, the dollar fell to very low levels and became very undervalued — this tended to coincide with widespread talk about the dollar’s preeminence, which turned out to be, at least for that era, wrong. And I do share the views of some people who believe, as a result of US policies, conditions are more conducive to a sustained period of dollar weakness. This requires strong ongoing evidence that Europe, China and much of the rest of Asia continue to manage COVID-19 better than the US, and that their cyclical recoveries from the pandemic continue to surprise relative to the US.

Now as for the first question, about the demise of the dollar’s dominance, let me repeat that this is largely a separate issue, but I encourage any reader to be careful about getting sucked into this belief in making an investment or hedging decision.

It is quite possible that the use of the dollar can decline, and start off a systematic decline even when its value is strong. Indeed, in the past couple of years when its value was largely rising, decisions made by US policymakers to use the dollar’s dominance as a way of penalising other countries has resulted in those countries reducing their share of dollar currency reserves. Russia is a particular example, and there is some modest evidence that China is doing likewise.

And the opposite can also be true.

Ultimately, the dollar’s dominance cannot persistently outweigh the relative decline of the US economy in the world, which has been occurring now for 20 years. At some point, it will start to be replaced by something else. Whether that is, the renminbi, the euro, Bitcoin, the return of gold — all are conceivable, and may happen. It might be starting now. But don’t confuse that with where the dollar’s price is heading against other currencies in coming days, weeks, or in 2021.

This article was originally published in The Article.




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Zimbabwe's Elections Were Meant to Start a New Era

Zimbabwe's Elections Were Meant to Start a New Era Expert comment sysadmin 14 August 2018

Emmerson Mnangagwa has been declared president of Zimbabwe amid protests and violence but Zimbabweans are now in a post-political, economy-first mood, writes Knox Chitiyo.

People queue in order to cast their ballot outside a polling station located in the suburb of Mbare in Zimbabwe’s capital Harare, on 30 July 2018. Photo: Luis Tato/AFP/Getty Images.

Before Zimbabwe’s general election on 30 July, there was a lot of talk about there being ‘landmark change’ and ‘credibility.’ But in many ways it was déjà vu. President Emmerson Mnangagwa’s ruling ZANU-PF party won the parliamentary vote, taking a majority 144 seats out of 210. The opposition MDC Alliance, a seven-party coalition led by Nelson Chamisa, won 64 seats—an improvement on their 2013 showing of 44 seats, but still falling far short of expectations.

The presidential results were much closer. After clashes on Wednesday, the incumbent Mnangagwa was declared winner early Friday morning, taking 50.8 per cent of the vote against Chamisa’s 44.3 per cent. The 21 other independent presidential candidates polled less than 5 per cent between them.

The polls didn’t quite live up to the hype. There was much that was positive: the prelude and election day were peaceful, with a minimal military presence. Opposition candidates were able to hold nationwide rallies (including in ZANU-PF’s rural heartland) without interference—an electoral first. ZANU-PF leaders and the military called for a peaceful process. Four women candidates contested the presidential vote, another first. More than 5 million Zimbabweans registered out of an eligible voting population of 7.2 million, and there was a near record 75 per cent turnout on voting day. Zimbabwe invited official observers from 46 countries and 15 international organizations, and, for the first time since 2002, observers from the EU, the Commonwealth and the US were present.

But shortcomings included late public access to the imperfect biometric voters roll and controversies about the ballot papers. There were also misogynistic social media attacks and threats against female candidates and the Zimbabwe Electoral Commission (ZEC) chair Justice Priscilla Chigumba.

The three-day wait for presidential results saw a further decline in public trust in the ZEC, and the opposition’s premature announcement of a Chamisa victory only fanned the political flames.

On Wednesday, six unarmed civilians were shot dead by soldiers in Harare, with dozens more assaulted. A Joint International Observer Mission statement promptly condemned the violence and called for restraint.

The election process was a boon for democracy, but ironically the result has entrenched the two-party parliamentary system and marginalized alternative voices. Mnangagwa has been conciliatory in his post-election statements, saying that Nelson Chamisa has a ‘crucial role to play’ and calling for unity to ‘build a new Zimbabwe for all.’

But Chamisa’s MDC Alliance has refused to accept the results, calling them ‘fake’ and a ‘scandal.’ The MDC has raised genuine transparency concerns and will likely challenge the results in court, but much of this may be cosmetic—with little chance of a 2017 Kenya-style presidential re-run. There is no critical mass of opposition parties to sustain a challenge, nor is there a popular appetite for a protracted political feud.

Zimbabwe’s democracy agenda may be heading into the slow lane, and Chamisa may be pressured by his coalition partners to make a political accommodation with Mnangagwa. Nevertheless, despite setbacks, Zimbabwe’s opposition and civil society has a long history of resilience under pressure and the struggle for democracy will continue.

Mnangagwa has a full in-tray. He has to unite a fractious ZANU-PF and manage internal civil-military and generational faultlines. Beyond that, he may need a public reconciliation with Chamisa—similar to how in Kenya and Mozambique, similar incumbent-opposition quarrels were mended by public rapprochements.

But Zimbabweans are now in a post-political, economy-first mood. Resolving the cash crisis is crucial. Few Zimbabweans can withdraw more than $50 a day from banks or ATMs—and much of this is paid out in unpopular ‘bond coins.’ The formal sector has contracted to only 20 per cent of the economy, and the informal sector lacks the capacity to push an economic renewal.

Zimbabwe’s new internationalism is premised upon the 2015 Lima process economic reform pathway for debt arrears clearance. (The country has a $10 billion foreign debt.) There has been a modest increase in foreign and diaspora investment, but the big-money Chinese, Russian and other pledges are long-horizon projects. What Zimbabwe needs is a short-term economic stimulus—to support small and medium-sized businesses.

For this to happen, Mnangagwa has to stay the course on economic reform, ease of doing business and the anti-corruption agenda. The pivot from reform to transformation in Zimbabwe will require all hands on deck, including civil society, the opposition, Zimbabwe diaspora and foreign investors, in a partnership for development.

A positive global verdict on the elections could supercharge investment, but time will tell whether these polls have been a deal-maker or a deal-breaker.

Zimbabwe’s elections often split the global south and the global north, and this could be the case again. The EU will have to decide whether to continue their incremental rapprochement with Zimbabwe, or accelerate to the reciprocity-based, ‘Re-Engagement 2.0’ approach currently favoured by the UK although the US is unlikely to lift statutory sanctions anytime soon.

Zimbabwe’s possible return to the Commonwealth could also be divisive, given the broader global context of the perceived existential clash between beleaguered liberal democracy and the rise of populist—and popular—autocracies across the globe.

President Mnangagwa—along with South Africa’s President Cyril Ramaphosa, Mozambique’s Filipe Nyusi and others—belong to a pragmatic new wave of regional economic reformers nudging liberationism away from ideology. He now has an electoral mandate to lead a divided country. For sisters Chipo and Tendai, both businesswomen based in Harare who voted for Mnangagwa and Chamisa respectively, the future needs to come now. ‘There is too much talk,’ they said, ‘we live every day between hope and despair. We need cash and jobs. We are tired of being tired.’

This was originally published in TIME.




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