This will shift the US net saving rate into negative territory much deeper than it was during the global crisis. The effect of this is ominous for America’s future. After eliminating the required depreciation of the aging capital stock of buildings and infrastructure, the United States is, in effect, liquidating the net savings required to expand productive capacity. Without borrowing the surplus saving from abroad, growth is impossible. As a result, the current account deficit will deepen. All when the dollar loses its special privilege. With America’s position as the world’s dominant reserve currency slowly eroding since 2000, foreign lenders are likely to demand concessions on the terms of such massive external financing.
This usually takes two forms – the interest rate and / or currency adjustment. The Federal Reserve has finally switched to a strategy that takes into account average inflation rather than a set target, and has promised to keep interest rates near zero for several more years. This means that the interest rate channel has effectively closed. As a result, more current account adjustments will now be imposed by the weak dollar.
In the second quarter of 2020, net domestic savings – savings adjusted for household, business and government consumption – returned to negative territory for the first time since the global financial crisis.
The high value of the US dollar makes it especially vulnerable. Despite the recent declines, the general index of the real effective exchange rate of the dollar is still about 27% higher than its lowest level in July 2011. This makes the US currency the most valuable major currency in the world, just as the United States was drawn into an unprecedented current savings account cycle. Currencies are relative prices. The dollar has always benefited from TINA’s alluring magic, that is, there is no alternative to it. Think again. The July 21 agreement on a next-generation European Union fund of 750 billion euros ($ 858 billion) establishes a pan-European fiscal policy. This is what should strengthen the undervalued euro. Renminbi, gold and cryptocurrencies are also alternatives to the once invincible dollar. The dollar index fell by 33% in real terms in the 1970s and mid-1980s, and another 28% from 2002 to 2011. During those three periods, the average domestic saving rate was 4.9% (compared to -1.2% today) and the current account deficit was – 2.5% of GDP (versus -3.5% today). With the United States squandering its super-privilege, the dollar is now more vulnerable to a sharp correction. Collapse looms.
* Article published in the Financial Times on October 5
** Member of the Education Authority at Yale University and former president of “Morgan Stanley – Asia” and author of “Unbalanced”
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