A year ago, it might have seemed improbable that of the European Union and the US, it would be the latter that was falling behind. Since then, elections in mainland Europe have reaffirmed their collective unity and stability, meanwhile US President Donald Trump’s administration has not. Looking at what has happened to the dollar in light of a strengthening euro might give some insight into global power shifts.
The US president's agenda is stuck in Washington swamps, his business councils have been dismantled and investors have pretty much said goodbye to their hopes of wide sweeping reforms that would provide a kick to the ageing business cycle.
This ageing business cycle is proving particularly problematic for consumption. The US's job machine is still running at full speed thus supporting domestic consumption; this means the point of labour scarcity is fast approaching. Once this point is reached, it will trigger a slowdown unless productivity and wages pick up. Indeed, if consumers have continued to spend, they have done so by depleting household savings (which have dropped from 5.4 per cent to 3.6 per cent of disposable income in the past year) and borrowing money – to the point that consumer credit has hit an all-time high.
At the same time, the likelihood of large-scale tax reform, in particular, is looking more unlikely than ever. The Republican Congress will manage at best to pass a 2018 Budget including temporary tax cuts which, while certainly welcome, will be inadequate to the task of countering the cyclical slowdown currently unfolding.
On a higher level the US's geo-political credibility has been penalised by the more isolationist tone and the unpredictability of the White House. By pulling out of the Trans-Pacific Partnership (TPP), by hinting that the US nuclear umbrella might not continue to protect NATO’s European member states and by turning the strategic decision-making process into an improvised, incoherent jumble, the current president has led the US’s grip on global leadership to be questioned – and offered Europe and China a golden opportunity to bolster their own.
This can be seen by looking at the relative weighting of the dollar. Currencies have a universal influence on prices and so, have traditionally been one of the purest ways to view a country’s outlook, politically and economically.
Key Points
- The likelihood of large-scale tax reform in the US is looking more unlikely than ever.
- The euro’s steady appreciation versus the US dollar has continued unabated in August.
- The new paradigm for the euro–dollar pair has emerged as a potential source of market disruption.
It makes sense to view the euro–dollar exchange rate in 2017 as the mirror image of what it was in 2014, when the US enjoyed a much rosier economic outlook than the eurozone, though it goes deeper than mere economic comparisons. In an era where quantitative easing has pushed interest levels near to zero, thus ensuring rate differential which is far smaller than usual, currency traders have been forced to become far more attuned to political developments.
The euro’s steady appreciation versus the US dollar since the start of the year has continued unabated in August. This trend reflects above all the weakness of the US dollar, which is even starting to see its safe haven status questioned, as demonstrated by the accelerating rise in Europe’s common currency following the recent geopolitical tension sparked by North Korea. It is also worth noting that the price of gold – the ultimate reserve ‘currency’ – has also benefited from that trend since the start of the year.
