The End of the Dollar’s Exorbitant Privilege
The comments below are an edited and abridged synopsis of an article by Stephen Roach
The US took advantage of having the world’s reserve currency by having the world support America’s standard of living. That privilege is about to end. A crash in the dollar is likely, and it could fall by as much as 35% by the end of 2021.
The reason: A collapse in domestic saving and a current account deficit. In the 2nd quarter of 2020, net domestic saving went negative for the first time since the global financial crisis. At -1.2%, net domestic saving as a share of national income was 4.1 percentage points below the first quarter, the steepest quarterly plunge in records that go back to 1947.
The current account deficit followed suit. Lacking in savings and wanting to grow, the US levered its exorbitant privilege to borrow surplus savings from abroad. That sent the current account deficit to -3.5% of GDP in the second quarter—1.4 percentage points below that in the first period, and also the sharpest quarterly erosion on record.
Going into the Covid-19 pandemic, the net domestic savings rate averaged just 2.9% of gross national income from 2011 to 2019, less than half the 7% average from 1960 to 2005. This left the US vulnerable to any shock.
As budget deficits pile up in the years ahead, further downward pressure on domestic saving and the current account will intensify. The latest CBO estimates put the federal deficit at 16% of GDP in 2020 before receding to 8.6% in 2021. Assuming that Congress agrees to another round of fiscal relief, a much larger deficit for 2021 is likely.
This will take the US net saving rate into negative territory. After setting aside the required depreciation, the US is liquidating the net saving required for the expansion of productive capacity. Without borrowing surplus saving from abroad, growth is impossible. The current account deficit will deepen, and the dollar will lose its special privilege.
The dollar’s current value makes it vulnerable. Despite recent falls, a broad index of the dollar’s real effective exchange rate remains some 27% above its July 2011 low. That makes the greenback the world’s most overvalued major currency, just as the US gets sucked into an unprecedented savings-current account vortex.
Currencies are relative prices. The dollar benefits from the thought that there is no alternative, but there is. The Next Generation EU Fund of $858 billion establishes a pan-European fiscal policy, which should boost the undervalued euro. Gold and the renminbi are also alternatives to the dollar.
The dollar index fell 33% in real terms in the 1970s and the 1980s, and another 28% from 2002 to 2011. During those periods, the net domestic saving rate averaged 4.9% (-1.2% today) and the current account deficit was -2.5% of GDP (-3.5% today). The dollar is now vulnerable to a sharp correction. A crash is looming.