THE world was dumbfounded when fanatic supporters of Donald Trump pierced the heart of the United States democracy. The US Capitol building, where the US Congress and Senate hold office, fell under their control for a few hours. The shock was not limited to politicians. The market reeled. Once again, the position of the US dollar as the anchor of stability for the world economy is under scrutiny.
That riot just amplifies the market’s doubts in the US dollar that have been raising since last year. To save an economy hit hard by the pandemic, the Federal Reserve must do whatever it takes. One of them has been an uncharted course: pumping unlimited dollar liquidity. So far the US economy is relatively safe and the financial market even enjoyed an euphoria from the flood of dollars. But the policy has left residues that no one is sure how to handle. The excess supply of US dollars will eventually cause problems.
The Fed’s balance sheet has grown to extraordinary levels, ballooning from US$4.16 trillion at the end of 2019 to US$7.36 trillion at the end of 2020, nearly double in just one year. And almost all of the Fed’s assets are just ‘papers’, US government bonds.
Previously, the highest the balance sheet of the Fed was US$4.51 trillion on January 2015. Until the end of 2019, before Covid-19 pandemic broke out, the Fed had been slowly deflating that bubble. But alas, once the pandemic happened, their plans to fix the balance sheet had been given to efforts to save the economy.
Now, it is hard to say that there are no problems with the Fed’s balance sheet. Can the world accept the reality that the Fed, which has practically become the central bank of the world, has so much US government debt securities as their assets? It is no surprise that the US dollar keeps under pressure, losing seven percent against other main global currencies throughout 2020.
The riots at the Capitol building have accelerated that decline. The Dollar Index, which measures the US dollar against six main currencies, collapsed to 89.9 in the weekend on January 8. This weakening has made the exchange rates of the renminbi and the euro against the US dollar reach record high since July 2018. The currencies of emerging economies are also enjoying a boost. The MSCI emerging market currencies index has reached a new record at 1,731, surpassing its previous highest level on March 2018.
Unfortunately, these good tidings do not extend to rupiah. It appreciated to below Rp14,000 per US dollar only for a day. By the weekend on January 8, the rupiah had returned to over that psychological limit. If we use the dollar index as a comparison, the rupiah should be much stronger. As of January 26, 2018, when the dollar index was at 89, just as it is now, the rupiah at that time was going for Rp13,306 per US dollar. Due to various problems in the Indonesian economy, the rupiah’s movements against the weakening US dollar will take a different course than those of the main global currencies.
Meanwhile, the world just has to maintain its confidence in the US dollar. Still, there are some positive factors here. The US is still the biggest economy in the world. The Fed is independent and transparent in conducting its monetary policies. Last but not least, financial industry infrastructure in the US is still the best. According to International Monetary Fund data, the total value of all foreign reserves in the world as of Q3 2020 is equivalent to US$11.5 trillion. Of that number, US$6.93 trillion, or 60.2 percent, is in US-dollar denominated assets.
Right now, the only possible replacement for the US is China, if economic power is the only consideration. However, when taking into account policy transparency and monetary authority independence from government intervention, it is impossible for China to earn the trust of the entire world. Just few words on transparency of Chinese authority, until now, no one can explain the fate of Jack Ma. Since Chinese authorities cancelled the initial public offering for Ma’s Ant Group in the eleventh hour last November, Ma has never been seen in public.
So, it looks like the US dollar will keep getting weaker. But, remember TINA, there is no alternative. The US dollar will stay dominant for some unforeseeable future.