Why A Weakened US Dollar Is Good For The Economy: It’s always a big question mark of where the US dollar will settle, and there are plenty of reasons why.
The greenback is relied upon to service a big chunk of world debt that’s been issued in the currency, it’s the settlement basis for a significant portion of international trade.
It holds majority status as a reserve currency by central banks easily besting the euro and other major currencies, and it is also on the other side of a vast majority of foreign exchange transactions.
And as if that weren’t enough, it’s also used by countries to peg their currencies.
That means if interest rates rise in the US, central banks of countries whose currencies are pegged to the dollar follow suit, and the same holds true when rates fall as seen more recently.
Fortunes are intertwined then on the financial front, and it was a sigh of relief when the US Federal Reserve (Fed) opted to reduce rates and change its inflation policy to allow for rates to remain low potentially for years to come.
That’s when it comes to interest rates and liquidity in the financial system, but then comes the next matter: US dollar weakness relative to other currencies that aren’t pegged to the greenback.
A lower interest rate and putting liquidity into the system usually results in a weaker currency, and the need especially arose at the start of the pandemic when financial markets suffered a “sell everything” moment where assets nearly across the board were being dropped in the hunt for liquidity.
The US dollar outperformed at the time before the US central bank stepped in to ease liquidity concerns.
Financial market themes usually involve “risk-on” vs. “risk-off,” where the former labels days of increased risk-taking with investors snapping up equities while dumping safe haven assets like bonds and gold.
And the latter is used to describe moments where the opposite occurs as investors fear economic contraction and prefer fixed returns like bonds and avoid riskier assets like stocks.
Since the start of the pandemic however, we’ve been witnessing some days of “buy everything” vs. “sell everything,” where on days of assurance of both fiscal and monetary policy, everything goes up at the expense of the dollar.
Pullbacks days see a retreat in asset prices in general with the greenback clawing back lost territory. And since we’ve been seeing more “buy everything” moments, the net result has been a generally weaker dollar, with the USD index down over 10% since its peak in March.
While it hasn’t weakened against all currencies (that has been reserved primarily for currencies whose central banks have swap lines opened with the Fed to improve liquidity conditions), it has come as boon to currencies pegged to it, as a weaker greenback results in a weaker currency that’s pegged to it.
So, what exactly are the benefits of a weaker currency?
The most obvious involves a boost in a country’s export sector, as a weaker currency would make goods domestically produced cheaper to purchase by foreigners at a time when global demand has been generally depressed.
That would also translate into making real estate and tourism more affordable for foreign investors and tourists respectively, and potentially attract inflows into the country.
And while prices on imported goods that are priced in a more expensive foreign currency may rise, this would only occur if companies tapping into the domestic market face a lack of domestic competition and strong enough demand.
Even in the absence of domestic competition, it’s unlikely demand would be strong globally as countries continue to battle the pandemic.
But should it result in a price increase, it would boost inflationary readings at a time when central banks are attempting to battle deflationary pressures.
There’s also the need that foreign governments (and in some cases, companies and households as well) have for the US dollar, with a weaker dollar meaning they’ll have to pay less to obtain them to service ongoing USD obligations and debts, easing liquidity concerns at a time when it’s a crucial component to the survival of business continuity.
While a stronger currency might sound nice, from an economic standpoint, a general weakening in the dollar in the current economic climate is seen as more befitting.
But with other central banks also lowering interest rates and flooding their respective systems with liquidity, greenback weakness has been gradual and prone to plenty of retracement.