Harry Geels: Dollar, what are you doing?
This column was originally written in Dutch. This is an English translation.
By Harry Geels
The first economics book I ever bought was by Hungarian stockbroker and freebooter André Kostolany. The title: ‘…En wat doet de Dollar?’ or in English: ‘…And what is the Dollar doing?’ I recently took the book off the shelves again, because the ‘million-dollar question’ is back on the agenda in the Trump era.
How exactly life takes its course is a particularly philosophical question. In preparation for a lecture I will be giving on Friday 7 March in Schagen, I reread the first economics book I bought in the exact same bookshop where the lecture will take place, ‘…En wat doet de Dollar?’ or in English: ‘…And what is the Dollar doing?’. The purchase of the book is a vague memory, an uneasy shuffling along the shelves, during which a book with an intriguing green cover and thick green letters, with a large dollar bill, apparently caught my attention.
The title of the book is still a relevant question, especially in the Trump era, as the new American government is investigating strategies to weaken the dollar. This could have major repercussions for investment portfolios, as they, especially those of institutional investors, contain increasing dollar risk. Wall Street cannot stop talking the Mar-a-Lago agreement. But before we attempt to answer the million-dollar question, let's return to André Kostolany's book.
In the maze of currency speculation
When rereading the book, I noticed something remarkable: how much some of Kostolany's ideas have apparently become interwoven with my current body of thought. At the time, I found the book, which bears the subtitle ‘In the Maze of Currency Speculation’, to be a work full of anecdotes and vivid imagery. For example, Kostolany compares the currency markets to a dog walking in front of its owner on a long leash. The owner, the fundamental economy, walks calmly and predictably. But that does not apply to his dog, the exchange rate.
The dog runs ahead, sniffs here and there, sometimes falls far behind, but always returns to his master. This illustrates how exchange rates sometimes fluctuate wildly, but in the long term tend towards their fundamental value. Upon rereading, three more things stood out. Kostolany argued that interventions by central banks are pointless (often due to poor timing and overestimating their own abilities), that the abolition of Bretton Woods would lead to inflation (direct hit!), and that mass psychology plays a major role in price formation.
...And what is the dollar doing?
Two-thirds of the average share portfolio currently consists of American shares, so the dollar exchange rate has a major impact on future returns. Since the credit crisis, the relatively sharp rise in the American stock markets has been accompanied by a strengthening dollar. This has given investors in America a double advantage. In Kostolany's terms, this increase would represent the fundamental strength of the American economy. But other factors are also at play.
A currency does not necessarily have to be strong because of this fundamental story. The current strength of the dollar can also be explained by the weakness of other important currencies in the world. The euro is part of a flawed system: one currency and one policy interest rate does not work when countries have different economic growth stories. The yen and renminbi are kept weak by the (monetary) authorities. In Japan, this is done through a policy of extremely low interest rates, in China through a system of ‘managed floating rates’ by the central bank (PBOC).
Figure 1: Dollar index (1967-2024)
Source: TradingView (adapted)
Three upward cycles
The dollar's strength is best measured against a basket of several other major currencies, also known as the Dollar Index (DXY). This enables us to include forerunners of the euro, for example, and draw a longer-term picture. Figure 1 shows three cycles. The first upward trend of the dollar (index) began in the early eighties and coincided with Paul Volcker's strict monetary policy to combat high US inflation in the seventies and early eighties.
The second cycle runs parallel to the dot.com bubble, when there was high demand for American internet stocks and a unipolar world that was also described as the golden age: high economic growth, low inflation and an underlying narrative that the internet would make the trees grow to the sky. We are now seeing the third upward cycle since the low point of the credit crisis. Since then, the dollar has been considered a safe haven, a narrative supported by the rise of tech giants.
Mar-a-Lago
Every upward cycle ends. The first cycle ended in 1985 due to deliberate policy, also known as the Plaza Accord. The major economic powers agreed to weaken the heavily overvalued dollar in view of the large double deficit of the American government and the trade balance. In addition, Germany and Japan became fast-growing industrial nations. The second upward cycle ended with the bursting of the Dot.com bubble and the initial belief in the euro as a second reserve currency.
And the end of the third wave? Of course, you can never time the peak (or bottom), but if the Americans have their way, it will happen sooner rather than later. The large deficit in the American trade balance is a problem. More needs to be exported and less imported. Given the political conflicts in the world, large investors and central banks also seem to want to spread their currency reserves more widely. And so, as stated earlier, there are rumours about a new Plaza Accord, already dubbed the Mar-a-Lago Accord, the idea has already been worked out.
The big ‘but’ is that there is no good alternative to the dollar yet. With Trump's negotiating style and the lack of goodwill, a Mar-a-Lago agreement will not be reached any time soon. Furthermore, the euro continues to struggle. There is also no alternative yet to a reserve currency of the BRICS countries, if one will ever come about. Nevertheless, it seems wise to make the portfolio less dependent on the dollar when the opportunity presents itself. Incidentally, when asked ‘what is the dollar doing?’, Kostolany replied: ‘it is moving’.
This article contains the personal opinion of Harry Geels
