Despite devaluation: ‘No other currency can supplant the dollar’

• Stephen Li Jen
  CEO
  Eurizon SLJ Capital

• For the dollar to be a safe haven, the US Treasuries need to be a safe haven
• No other currency can supplant the dollar, but its share in the world’s reserve holdings should continue to drift lower, while retaining the n. 1 spot.  
• The current weak dollar situation benefits the US

In the current setting, the US economy remains reasonably robust.  The negative Q1 GDP print reflected primarily frontloading of imports and not anything sinister about underlying domestic demand.  In fact, capex was remarkably strong, and consumption was not weak. Thus, the sell-off in US equities reflected a portfolio shift out of the US rather than something that was motivated by fears of a US recession per se.  

Is the US dollar still a safe haven?

The world had already bought a lot of USD assets, both equities and bonds. Years of current account deficits and capital inflows have led to a situation where the US now has a net foreign liability position of 85% of GDP, or USD 25 trillion.  This lopsided cross-border holdings of assets is so large that a temporary change in global sentiment could trigger very large flows out of the US equities, bonds, and the dollar.  This portfolio adjustment was not motivated by recession fears but by a recalibration of the future profitability of US corporations.  

A second reason why US bonds failed to rally this time, when equities sold off, was that the trigger of the equity sell-off was itself stagflationary, with ambiguous implications for bond yields.  This wasn’t a typical demand-driven recession that would push capital from the equity markets to the bond market.  

For the dollar to be a safe haven, the US Treasuries need to be a safe haven.  The nature of the shock and the configuration of the global portfolio holdings simply did not allow the dollar to be a safe haven asset.  However, if we see a deep recession in the US, I still believe the dollar would rally in that case. If the global economy enters a sufficiently scary state, the dollar should still be a safe haven.  

Despite global upheavals, the US dollar remains the dominant reserve currency

the past 25 years, EURUSD traded as low as 0.80 and as high as 1.60.  Throughout this period, very few people talked about the dollar losing its hegemonic status as a reserve or international currency.  We have traded between 1.05 and 1.15.  From a historical perspective, there is nothing sinister about the recent move.  In fact, the fair value of EURUSD, we think, is in the 1.20-1.25 range.  

The dollar has been overvalued for a very long time – a point we have repeatedly made in the past years.  We warned that, from an overvalued position, it would take not so big of a shock to push the dollar lower.  All the talk about ‘American Exceptionalism’, we believed, were mis-placed and an exaggerated description of the US and USD assets.  Similarly, all the talk about ‘Negative American Exceptionalism’ is also an exaggeration, we believe.  The US and the USD were never that good, but they are not as bad as some may think now.  

No other currency can supplant the dollar.  However, the dollar’s share in the world’s reserve holdings should continue to drift lower, while retaining the number one spot.  

As an international currency, however, the assessment is different: there is zero evidence of the dollar losing its dominance as an international currency.  

I’m bearish on the dollar and have been for two years.  But I do not believe dollar depreciation will be accompanied by the USD losing its international status.  

The USA is currently benefiting from a weaker dollar

 A weak dollar would be a good substitute for tariffs.  This is why I support the Mar-a-Lago Accord idea and think that if only the world could agree to accepting a 20% devaluation of the dollar, perhaps they could persuade the US not to impose a 20% tariff.