Current affairs, Fundas, Recent

Why is the US Dollar tanking?

Last year when I went to the US I had to pay more than 77 Indian rupees to get one dollar. Yesterday, I checked, I have to give about 74.85-75 of our Rupee to get one dollar.

In financial parlance, the Indian rupee has appreciated and the dollar has depreciated.

The mighty US dollar had been on a tear in the last decade when it rose by 40%.

After reaching a peak in March, it is now trading more than 6% lower as compared to other major international currencies.

The value of the dollar is measured via the dollar index which tracks the value of the dollar as against the value of six other major currencies- Euro, Swiss Franc, Japanese Yen, the Canadian dollar, British pound, and Swedish Krona.

The exchange rate is a price of currency and is affected by the demand and supply like any other commodity. It is a complex web and there are many factors that affect the currency of a country.

The dollar is the world’s reserve currency and so its dominance in the world is humongous. Banks all over the world have a high percentage of their reserves in dollars. (> 60%).

A lot of the world trade is also denominated in dollars. For instance, if Malaysia is selling goods to India but does not want to accept the Indian Rupee. It can ask for payments in USD.

Similarly, if India is exporting to Bangladesh or South Africa or any other country, it can ask for payment in USD.

The reason to ask for USD is that the confidence in the US & its economy is high and the currency is universally acceptable.

Why is USD declining?

Some of the factors at play are listed below.

  • Post the coronavirus the Federal Reserve (the Central Bank of America) has reduced interest rates to zero to save the economy and businesses. This has made holding USD less attractive as you earn next to nothing as interest for holding dollar or dollar assets.
  • The US economy seems to be taking longer to bounce back from the coronavirus as compared to other western economies. The high unemployment numbers and slow recovery has given rise to the perception of a weaker US economy hence the flight away from USD.
  • The US is going into the election this November to elect their new president. The uncertainty and the continuing trade war against another giant country China is causing some nervousness.
  • US fiscal deficit ie – It is spending trillions of dollars which they don’t have which will have to be funded by foreign investment.

A weaker currency is not necessarily a bad thing for a country as there are some benefits to it. It makes exports attractive, foreigners are happier to invest in that country.

Multinational companies that earn a lot of their profits in other countries can send back more of their own currencies. For eg a US company like Kraft Inc who sells cheese in Europe can now send more USD back home for the same quantity of cheese sold.

This has also spurred the stock price of such companies who earn a huge revenue overseas.

Despite the fact that the USD has been declining a bit, toppling the US dollar is a tall ask. It will take a lot of missteps by the US and the rise of another global power like China or a resurgence of Europe to make it happen.

Investment bank like Goldman Sachs is estimating the relative worth Euro to rise by 6% in the next year. Speculators and traders in the currency may start betting on that.

You can read more about the dollar drop in the Charles Schwab report here. Brokerages are expecting USD to depreciate further by 8-10%.

Nonetheless, it is what the tea leaves are suggesting and it may make sense to buy some Euros rather than USD this year.J.

  1. Sejal Goel

    August 11, 2020

    Nice Read.

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