Monday, August 10, 2020

The Dollar's long Journey down has started

Daniel Gros is Director of the Center for European Policy Studies. He wrote an article to express his unease about the rise of the Euro.

By the way, it happened that when the Euro was first adopted as the currency of the European Union in 1999, it was given a par value of 1 to 1 with the American dollar. It was also called the Euro Dollar to distinguish it from everything else that was European.

In time, however, everything pertaining to Europe, dropped the Euro designation, leaving its use only for the currency. This is why the word “Euro” has come to mean the European unit of currency and nothing else. Today, one Euro converts into one American dollar plus 18 cents, and the gap continues to widen in favor of the Euro. This is why Daniel Gros is sounding the alarm. It is not that he is worried the American currency is sinking; it is that he is worried the European competitiveness is sinking as a result of the rise in the Euro.

But how did the paradigm begin to shift? It all began when Europe was seen to have managed the COVID-19 pandemic wisely whereas America managed it foolishly. The result is that Europe maintained its economic indicators, especially the level of employment, steady. At the same time, however, America saw its economic indicators, especially the level of employment, deteriorate. This has increased the confidence of investors throughout the world in the European economy, thus began the bidding for the Euro, and its rise in value.

Whereas mismanagement of the pandemic has played a role in creating the current situation, there exist structural reasons in both economies for this to have happened, says Daniel Gros. In fact, he cites two main reasons. One is that the dollar is used as the reserve currency by most nations, which means that people and companies the world over, trade goods and services using the dollar as medium of exchange. The result, says Daniel Gros, is that people around the world, have the incentive to maintain the dollar at a stable value for as long as they can, even when their own local currencies fluctuate.

The other reason, says Gros, is that Europe has a more open economy, making it dependent on export to the tune of 30% of its GDP, whereas America depends on export only to the tune of 12% of its GDP. This makes Europe more sensitive to the changing expectations of the international investors. At this time, the investors are up on the Euro and down on the dollar, which is reflected in the value of the two currencies.

This raises the question as to whether the current phenomenon is temporary or it is the harbinger of a new paradigm that's beginning to manifest itself. Well, if there is a lesson to be learned from what has unfolded so far, it is that when you are so cogent as to make your presence felt worldwide, every move you make affects not only those around you, but yourself as well because you cannot avoid being rocked by the waves you create. With this in mind, we parse the current situation and see where it leads.

Brutally stated, it all means that in the same way America is now feeling the effect of its mismanagement of the COVID-19 pandemic, it will feel the effect of its mismanagement of the economic relations it has been shaping of late with the rest of the world. That is, every move that America has made in trading with its partners, as well as every act in terms of sanctions, it has taken to punish those it does not like for whatever reason –– will ricochet and come back to haunt America in a way that can only be destructive.

This will further shake the confidence of investors in the dollar whose store of value will diminish in their eyes. And so, maintaining the dollar as a reserve currency or using it as a medium to facilitate the exchange in goods and services, will make less and less sense with the passage of time. Now, given that the world is awash with dollars, when the dumping of it will start and everyone will head for the exit at the same time, the rush will make Iran, Venezuela and North Korea look like paragons of stability.

Will that melt the American economy and bring it down to zero? No, it will not do so for the simple reason that America will not see the wholesale destruction of its means of production. There will still be mining, agriculture, manufacturing, construction and the related services such as transportation and storage. There will also be government services, healthcare, education, the leisure industries, even the financial services.

But what will happen is that the fall of the dollar will overshoot its mark, due mostly to the short-sellers, some of whom will make a fortune and some will lose fortunes they never had, and most likely end up in jail. When the dust will have settled, the dollar will be valued at perhaps half its current level compared to the Euro and the other major currencies. And America will have lost its designation as an economic superpower.