(Bloomberg View) -- The international financial system acts in funny ways. For example, the U.S. dollar has tumbled over the past 15 months, but inflation hasn't accelerated all that much, market interest-rates have barely budged and foreign-exchange reserve managers keep accumulating the greenback.
This raises a few questions, starting with why U.S. policy makers don't try to push the dollar down even more aggressively to aid exporters. After all, the Bloomberg Dollar Spot Index has dropped about 12 percent since the start of 2017, but the trade deficit has only gotten bigger. Why do foreigners keep buying U.S. assets if the dollar is dropping? What would it take for the dollar to lose its "exorbitant privilege" as the preeminent global reserve currency?
It seems that just about everyone loves the weaker dollar. Commodity producers are happy because prices for their goods generally rise when the dollar falls. The foreign earnings of U.S.-based multinationals go up via currency translation effects, so equity markets are happy on the whole. And since a weaker currency can make imports more expensive, the Federal Reserve is probably happy to see some upward inflationary pressures.
When it comes to trade, the reality is that dollar weakness is a mediocre tool to boost exports. Domestic producers tend to see dollar depreciation primarily as a way of juicing foreign earnings, not as a way of wedging themselves into foreign markets. To gain market share abroad, companies have to cut prices in foreign currencies, but the resulting gain would be uncertain and profit margins would certainly be sacrificed. Most decide to preserve their profit margins rather than cut prices. The dollar would probably need to depreciate 25 percent from current levels to have a big impact on trade.
Foreigners keep buying dollar-denominated assets through bouts of weakness because they have to and because they want to. They have to because they all like exporting to the U.S. and running trade surpluses. If you export but don’t want to import, you have to accept paper in return.
Any small- or medium-sized trading partner can decide not to accumulate dollar assets against its trade surplus, but if they did so as group, the dollar would fall off a cliff. The status quo, which they seem to like given their ongoing reserve accumulation, requires that they buy enough U.S. financial assets to keep the dollar more or less steady. The U.S. complains about the trade deficit, but no one at the Treasury Department stands at the door to prevent foreigners from coming in and buying the truckloads of bonds it sells to finance the budget deficit.
Foreign investors, at least those from the private sector, want to buy dollar assets in the same way that Americans buy Chinese-made socks or washing machines: They see greater value in the foreign product relative to the domestic product. Property rights in the U.S. are well-established and risks of appropriation are low, attractive attributes for investors based in countries where such rights are not secured. The U.S. is not the only place with deep asset and consumption markets, but it is the biggest and deepest.
Talking down the dollar absent a major policy shift works for a day or two, and the impact probably would get lower over time. If such talk convinces domestic and foreign investors that the Fed will pursue easy money policies or that the U.S. is a less attractive investment destination, then there can be a lasting impact, but the bar is high.
The dollar has large fluctuations driven by capital flows and asset markets, but foreign investors have confidence in the fundamental framework under which the U.S. economy and asset markets operate. For the dollar to depreciate and stay weak long enough for the U.S. to be seen as a low-cost producer would require this economic and capital market framework to fundamentally deteriorate. Should that occur, the loss from this structural deterioration would be far graver than any potential competitive gain from dollar weakness.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Steven Englander is the head of research and strategy at Rafiki Capital. He was previously the head of G10 currency strategy at Citigroup and the chief U.S. currency strategist at Barclays.
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