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The End of the Dollar's Exorbitant Privillege

By Kas Vardhanabhuti

October 9, 2020

The FT on 5th October 2020 published an article by Stephen Roach (a faculty member at Yale University and the former Morgan Stanley Asia Chair) titled “The End of the Dollar’s Exorbitant Privilege”. Roach thinks a crash in the dollar is likely and it could fall by as much as 35% by the end of 2021. 


Roach believes the lethal interplay between a collapse in US domestic savings and a growing current account deficit will cause a large drop in the value of the dollar. In 2Q2020, US net domestic savings dropped to 

-1.2%, the steepest quarterly plunge since 1947 (chart below). The US current account deficit also deteriorated. Without savings, the US levered up by borrowing surplus savings from abroad. This pushed the current account deficit to -3.5% of GDP in 2Q2020, also the sharpest erosion in current account on record (chart below). COVID-19 was clearly the trigger, but this was an accident waiting to happen because US domestic savings rate had structurally declined in the past decade and left a very thin cushion to protect the US economy from external shocks. 


As US budget deficits are likely to increase in the years ahead, a further downward pressure on domestic savings and current account will intensify. The latest estimates from the Congressional Budget Office (CBO) put the federal deficit at 16% of GDP in 2020. This is likely to rise in 2021 when US Congress agrees to another round of fiscal relief. This will take the US savings rate far deeper into negative territory than during the global financial crisis. Without borrowing surplus savings from abroad, growth in the US becomes almost impossible. Roach believes that this is when the dollar loses its special privilege. Foreign lenders are likely to demand concessions for such a large external financing. This normally takes two forms – an interest rate and/or a currency adjustment. Because the Federal Reserve has already promised to keep policy rates near zero for several years, the main option is to adjust the current account through a weaker dollar.

US Saving as % of National Income.png
US current account deficit.png

The US dollar on a broad index of real effective exchange rate is 27% above its July 2011 lows and Roach considers the dollar to be the world’s most overvalued currency. Historically, the dollar has always benefited from the lack of other alternatives. But now, credible alternatives exist in the form of euro, renminbi and gold. We believe cryptocurrencies, particularly Bitcoin, offer a viable alternative to holding the dollar. A trillion-dollar stimulus here and there adds up and the value of fiat currencies will continue to depreciate. To hedge the risk of currency debasement, companies are starting to keep a portion of their treasury funds in Bitcoin. For example, Microstrategy and Square Inc. have recently invested nearly $500mn in Bitcoin.


We think a controlled depreciation in the dollar would be positive for risk assets. Gold, Bitcoin, Ethereum and SPX have all shown negative correlations against the dollar in the past few months. US elections will undoubtedly bring volatility but when the dust settles, US Congress and Federal Reserve will focus on fiscal and monetary stimulus again. These actions should re-price risk assets higher. 

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