Weakening the dollar is the last throw of the dice in rescuing the global economy, according to Saxo Bank’s Steen Jakobsen.
In the online trading and investment specialist’s outlook report for the fourth quarter, published Thursday, Jakobsen said 2019 will most likely be remembered as the year that kickstarted a global recession, despite the lowest ever nominal and real interest rates.
“Monetary policy has reached the end of a very long road and has proven a failure,” Jakobsen, who is the chief economist and CIO at Saxo Bank, added.
The U.S. Federal Reserve in September made a second 25 basis point cut to interest rates, moving to a range of 1.75% to 2%. Its initial 25 basis point reduction in July was the central bank’s first rate cut since the financial crisis.
The European Central Bank (ECB), meanwhile, recently unveiled a package of measures to reinvigorate the euro zone economy, cutting its deposit rate by 10 basis points to -0.5% and launching a massive new quantitative easing (QE) program. A host of other central banks across the world have also embarked on dovish policy shifts.
Fears for the global economy have been exacerbated of late by the weakest manufacturing data out of the U.S. for over a decade, which compounded already fragile readings from across the euro zone and beyond.
“In a global system of failed monetary policies and a long and difficult path to fiscal policy, there is only one other tool left in the box for the global economy and that is lower the price of global money itself: the U.S. dollar,” Jakobsen said.
The outlook report pointed to an estimated $240 trillion of debt worldwide, roughly 240% of global GDP, and argued that too much of this debt is denominated in dollars, due to the greenback’s role as global reserve currency and the deep liquidity of U.S. capital markets.
This means the prospects for all asset classes have become a function of U.S. dollar liquidity and direction, Saxo Bank economists suggested.
“If the dollar rises too much, the strain in the system increases: not only for U.S. exports, but also for the emerging market with its high dependence on USD funding and export machines,” Jakobsen said.
“Weakening the Killer Dollar will likely put the final nail in the coffin of the grand credit cycle that started in the early 1980s, when the U.S. balance sheet was reset, and the USD was anchored by Volcker’s victory over inflation after Nixon abandoned the gold standard in 1971.”
Paul Volcker was Chair of the Fed between 1979 and 1987, and in 1980, he took the famously bold move of almost doubling the Fed funds rate to its highest point in history to put an end to double-digit inflation.
The cycle since then has been “turbocharged by globalization” and “lending money into existence via offshore USD creation,” the note added.
Saxo projected that a weaker USD could buy some time for the global markets, adding that it would not offer a structural solution, but represents the easiest quick fix and the one likely to face the least political opposition.
White House pressure
U.S. President Donald Trump has repeatedly chastised the Federal Reserve for what he perceives to be insufficient action to weaken the dollar, disadvantaging the U.S.
In a tweet Tuesday, the president wrote Fed Chair Jerome Powell and the central bank “have allowed the Dollar to get so strong, especially relative to ALL other currencies, that our manufacturers are being negatively affected.”
While market expectation is for the Fed’s policy path to remain largely unchanged, the Trump administration is likely to ramp up its pressure on the currency, Saxo analysts project.
Saxo Bank Head of FX Strategy John Hardy highlighted that as foreign central banks have lost the ability and willingness to accumulate USD reserves, they have increasingly sought funding from domestic sources.
“U.S. savers’ and U.S. banks’ balance sheets simply can’t absorb the torrent of issuance. Something has to give, and that something will be the Fed: whether it wants to or not,” Hardy said.
He suggested that in Q4, the Fed will likely be forced to respond in an increasingly substantial capacity to further liquidity provision, and the Trump administration may even wrest control of policy.
“A heel-dragging Fed and dark clouds gathering over the economic outlook almost ensures that the Trump administration will be scrambling for the funding it needs to ensure Trump’s re-election in 2020,” Hardy said.