Time to return to Triffin
When the latest meeting of the US Federal Open Markets Committee concludes next Wednesday (18 September), Chair Jay Powell is seen as certain to announce an interest rate cut, according to the CME Fedwatch tool. The only debate concerns whether it will be a quarter-point or half-point reduction from the current level of 2.25%.
And yet the US dollar continues to rise and it does so despite the huge U-turn in Fed monetary policy and President Trump’s attempts to both lean on the central bank for more action and talk the dollar down.
“The US dollar continues to rise and it does so despite the huge U-turn in Fed monetary policy and President Trump’s attempts to both lean on the central bank for more action and talk the dollar down.”
Using the trade-weighted DXY (or ‘Dixie’) index as a benchmark, the dollar stands at a two-and-a-half year high, around the 99 mark.
The dollar continues to gain ground
Source: Refinitiv data
This takes us back to a topic which I first visited last summer (Shares, 14 June 2018), namely the so-called ‘Triffin Dilemma’, whose influence should be followed by advisers and clients in the coming months.
When then US President Richard M. Nixon took America off the gold standard in 1971, the dollar effectively became the world’s reserve currency. Yet Professor Robert Triffin had already seen the catch in this in a book he produced in 1960 (Gold and The Dollar Crisis: The Future of Convertibility) as he argued that the greenback’s global reserve currency status would come at a cost – either to America or the world.
Triffin asserted that to provide the world with enough dollars, America would always have to run a trade deficit and import more than it exported, paying out more in dollars than it received, and run an ever-growing budget deficit for good measure.
This is all well and good while confidence in the dollar remains: lenders are happy to hold US Treasuries and the US is happy to run a trade deficit. But it becomes a problem if lenders lose faith (as they did briefly in 2008) or America’s trade policy is changed.
“And if Trump succeeds, dollars will flow back to America and drain the global economy of the greenbacks upon which it is reliant.”
This is where President Trump enters the equation. While he is happy to run ever-bigger budget deficits, his policy to put ‘America first’ means he is trying to reverse 48 years of economic history and reduce the US trade deficit. And if Trump succeeds, dollars will flow back to America and drain the global economy of the greenbacks upon which it is reliant.
The President has only made little, if any, progress with the US trade deficit so far but the dollar has gained during this period and the world’s economy and financial markets have already started to feel the effects.
The US trade deficit has not shrunk yet during the Trump Presidency
Source: FRED – St. Louis US Federal Reserve database
Argentina cries again
“A strong buck is traditionally seen as deflationary [… and] we are already seeing early signs of strain.”
A strong buck is traditionally seen as deflationary – it increases both the costs of (dollar-priced) commodities and the interest costs of those nations who borrow in dollars and not their own currency, a particular facet of emerging markets. Increased raw material costs eat into corporate profit margins and cash flows (and potentially dividends) while coupon payments to bondholders crimp governments’ scope to invest and potentially crimp economic growth.
We are already seeing early signs of strain.
First, the copper price, a traditional proxy for global economic health thanks to the industrial metal’s widespread use, is languishing at a two-and-a-half year low of around $5,500 a ton.
Copper price weakness is a concern
Source: Refinitiv data
Second, Argentina, a huge borrower in dollars, is suffering a collapse in confidence and its currency after President Mauricio Macri’s unexpected defeat in an early poll ahead of October’s election. That has forced him to postpone repayment of $7 billion in debt, talk about ‘reprofiling’ the nation’s $101 billion in liabilities and impose capital controls to support the peso.
This has left those brave souls who bought Argentina’s 100-year (or so-called ‘century’) bond in 2017 feeling pretty sick – though they really should have known better given Buenos Aires’s history of eight defaults since the early 1800s.
Argentina’s century bond and currency have collapsed
Source: Refinitiv data
Cracks in the wall
“It remains to be seen whether these cracks will become a major fissure in financial markets or whether central bank interest rate cuts can paper over them.”
It remains to be seen whether these cracks will become a major fissure in financial markets or whether central bank interest rate cuts can paper over them.
Currency controls have helped the Argentina peso to rally a little. But they did not work in Malaysia in 1997 and the ripple effects then were huge, even if it took until mid-1998 for them to knock global markets.
Advisers and clients are used to (relatively) easy access to markets and assets. Capital controls stop that, just like the gating of a fund – and we all know how badly that has gone down this year in one particular case.
It is to be hoped that the Triffin Dilemma does not become more acute and claim more victims. Investors need to keep an eye on emerging markets to check for any more market stresses – Turkey, for one, may not be out of the woods yet.