US is learning to love a weaker dollar

LONDON: US Treasury Secretary Steven Mnuchin has given the clearest indication yet that Washington’s long-standing “strong dollar” policy is over.

Yet while some countries may be nervous about their currencies rising as a result, there’s not much that could give the global economy and markets a bigger boost right now than a cheap dollar.

World stocks, gold, oil and credit markets have all powered higher since Mr Mnuchin said last Wednesday: “Obviously a weaker dollar is good for us as it relates to trade and opportunities.” Bond markets, under increasing pressure in recent weeks, have held their ground too.

A weaker dollar flatters US corporate earnings, which will support Wall Street and world stocks at large. It’s a perfect tonic for US equities that are beginning to look expensive.

On a price-earnings ratio basis, US stocks are their most expensive since 2002, and far more expensive than their euro zone, Japanese and British peers. That gap over their foreign peers has widened dramatically in recent months.

A weaker dollar also eases the strain on overseas borrowers of $11 trillion in dollar debt, of which $3.5 trillion is in emerging markets, which still bear the scars of past exchange rate crises.

For developed economies, the flip side of a weak dollar is a stronger euro and yen. While this complicates the ability of the European Central Bank and Bank of Japan to generate the inflation they desperately want, it also lessens the pressure on them to tighten monetary policy.

All else being equal, this is extra fuel for financial markets already firing on all cylinders. The withdrawal of global central bank stimulus might be more gradual than initially expected.

And if you buy into the Bank for International Settlements’ theory that the dollar is now the best barometer of global investor risk appetite and financial market leverage, a weak dollar can only be good news for world markets.

If risk appetite is weak when the dollar is strong, as the BIS says, then the reverse must also be true because a weaker dollar loosens financial conditions not just in the US but globally.

Former treasury secretary Larry Summers, writing in the Washington Post, warned that talking the dollar down risks generating an avalanche of selling that could have severe consequences. It risks pushing up US interest rates, which will mean “less investment, lower stock prices and more risk of financial instability”, he wrote. It could even spark a currency war.

But Mr Mnuchin is unlikely to pay much heed to these warnings. A lower exchange rate fits Donald Trump’s “America First” worldview perfectly. As long as the dollar’s decline remains smooth, it will not do world markets any harm either.