Rising US Dollar, Rising Global Risks

Rising US Dollar, Rising Global Risks
Photo by geralt (Pixabay)

As US dollar hitting record highs, it is no longer a sign of global recovery but also becoming the world’s premier fear gauge and global risk.

Recently, US dollar hit its 13-year high. According to the ICE Dollar Index, which measures the currency against a basket of six other currencies, soared to 100.6, its peak since April 2003. In view of analysts, US dollar is fueled by rising government bond yields (and the Fed’s anticipated rate hike), and expectations of Trump’s fiscal expansion (infrastructure stimulus).

Furthermore, as the dust is settling after the Trump triumph, the magnitude of the win – which ensures a Trump White House, a Republican Senate and a Republican House – translates to the kind of political consolidation that America has not witnessed in generations.

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If Republicans find unity and Democrats remain fragmented, Trump could have a major opportunity to promote policies that would further stimulate the US economy, growth and the dollar.

However, the future path of the US dollar may not prove as rosy as anticipated.

Forces driving US dollar risks

Recently, the Bank for International Settlements (BIS) – a sort of a think-tank of central banks – released an intriguing report, which argues that the US dollar has replaced the volatility index as the “new fear index.”

The mantle of the barometer of risk appetite and leverage used to belong to the VIX (or the Chicago Board Options Exchange volatility index). Before the 2008-9 financial crisis, there was a close correlation between leverage and the index. When the VIX was low, the appetite for borrowing went up, and vice versa. As a result, the VIX soared to its record 80.9 some eight years ago.

After years of ultra-low interest rates and now negative levels, and multiple rounds of quantitative easing that remain in effect in Europe and Japan, one would expect the VIX be elevated. And yet, it has averaged 16 in the ongoing year. Monetary easing by the world’s leading central banks in advanced economies have suppressed volatility for stocks, while compressing credit spreads.

In the process, the VIX’s predictive power has diminished, while the US dollar has become the indicator of risk appetite and leverage. This dynamic has distressing implications as it has pushed international borrowers and investors toward the dollar, with dollar appreciation exposing borrowers and lenders to valuation changes.

The recent dollar rally may not precipitate market confidence, but new risks.

Time to buckle up

Today, the US is the world’s greatest debtor nation and its sovereign debt has soared to $19.9 trillion. In the past, foreign investors have played a vital role in financing US deficits. Yet, in the past year, foreign central banks have sold almost $375 billion in Treasuries. Among the major sellers are China, which now holds the lowest amount of US debt since 2012 ($1.16 trillion), and Saudi Arabia, which has sold almost 30% of its US debt holdings in the past 9 months.

Recently, the Fed’s second-in-command Stanley Fischer announced that dollar liquidity is “adequate.” Yet, market skeptics have highlighted dollar illiquidity issues for several years.

If they are right, then the Fed rate hikes will boost the price of the US dollar as a kind of a global Fed funds rate, with the rising dollar tightening economic conditions worldwide. Instead of the expected Trump inflation, that would mean increasing deflationary constraints.

That would result in a chorus of criticism of the current dollar-based system by the large emerging economies (BRICS). Like the economist Keynes in the 1940s, they would point out that the fundamentals of the US economy do not support US market valuations and US dollar. Instead, the most-traded currency worldwide poses rising risks, particularly to the world’s fastest-growing emerging economies which today fuel global growth prospects.

What’s good for the US dollar may not be that good for the world economy.

Article By Dan Steinbock

Dr Steinbock is the founder of Difference Group and has served as research director at the India, China and America Institute (USA) and visiting fellow at the Shanghai Institutes for International Studies (China) and the EU Center (Singapore). For more, see http://www.differencegroup.net/

The original, slightly shorter version was published by Shanghai Daily on Nov 23, 2016

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Dr Steinbock is an internationally recognized expert of the multipolar world. He focuses on international business, international relations, investment and risk among the major advanced economies and large emerging economies; as well as multipolar trends in stocks, currencies, commodities, etc. Altogether, he analyzes some 40 major world economies and a dozen strategic nations, across all world regions.His commentaries are released regularly by major media in all world regions (see www.differencegroup.net). Dr Steinbock is CEO and founder of DifferenceGroup (for more, see www.differencegroup.net). In addition to advisory activities, he is affiliated as Research Director of International Business at India China and America Institute, and as Visiting Fellow in Shanghai Institutes for International Studies SIIS (China) and EU Center (Singapore). As a Senior Fulbright scholar, he is affiliated with Stern/NYU, Columbia Graduate School of Business and has cooperated with Harvard Business School. He has advised/consulted for the OECD, the European Commission, the Nordic Council and European government agencies, multinationals and SMEs, financial institutions, competitiveness and innovation organizations, and so on.

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