Mark Dow on Monetary Policy and the Dollar
That something is structural. There are two tectonic forces at work. There is a global dollar overhang that is being unwound. This is not a result of the U.S. monetary policy of the past 10 years, but rather the legacy of the last 60 years when liquid wealth across the planet had only one currency choice: the U.S. dollar. In the wake of WWII, as global trade increased, global wealth grew, and precautionary financial buffers got fatter, the global demand for dollars soared. We are now witnessing the backside of that slope. The decline of the dollar started in 2002 largely because this is when the paradigm shift in emerging markets began to take hold and people across the world began, slowly, to trust their home currencies. The financial deepening of foreign markets everywhere supported this process, as did the decline in transactional demand for the dollar (hotel bills in India and Brazil are now, for example, in local currency, not dollars). But this phenomenon doesn’t stop there. Central banks are major part of this unwind, too. As other currencies became more trustworthy and alternatives became available, they realized it is sub-optimal to hold such a large percentage of their reserves in one currency. Many of them have been seduced by the cyclical story as well. So they are trying to bring their dollar holdings down to a level that that more accurately reflects their trade and financial exposures. And the faster the dollar goes down, the more frenetically they force the pace of unwind. This stock adjustment will continue until a new equilibrium is found. The dollar is some 63% of global reserves, but the U.S. is now only 20% of global output. I am not suggesting that equilibrium is at 20%, but 40% doesn’t seem like an intellectual stretch. In any event, these statistics from the BIS (plus the flow dynamic of the feedback effect from heavy currency intervention in many EM countries) suggest the unwind of the global dollar overhang is far from over. Second, there has been massive supply shock to the U.S.labor pool. Technology over the past 10 years has effectively increased the labor force U.S. companies have access to by a large multiple. This presents an enormous structural challenge and, unfortunately, will keep downward pressures on real U.S. wages for a long time. Since nominal wages are notoriously sticky to the downside, one of the ways (but not the only one) for the “convergence” with the rest of the world to take place is through dollar depreciation. Policy makers are aware of these two structural stories, but really can’t do much about it. All they can do is try to support economic recovery, macroeconomic stability and ensure any decline in the dollar be orderly. We can vent at them all we want, but these two realities are not going to go away. Mark Dow is a senior portfolio manager at Pharo Management LLC, a global macro hedge fund specializing in currencies and global fixed income, and a Washington policy refugee.