What will happen to the U.S. Dollar?

Courtesy of CNBC.com

By Alejandro Sarmiento and Robby Sain

We have heard time and time again that we live in an unprecedented era. Outside of the social alterations COVID has induced, it has also sparked financial volatility to an extent comparable to the nation’s worst economic downturns. With soaring unemployment, historic fluctuations in the securities market and essential relief coming through stimulus grants… the list doesn’t seem to end. This economic fallout of the pandemic has brewed the perfect storm of free money and an uncertain future, begging the question: what will happen to the U.S. Dollar?

In terms of the economic background, the nominal value of currency usually follows one of two paths – a deflationary or inflationary path. The former occurs when supply outweighs demand, and thus, the prices of goods and services decline to entice consumption. The latter is deflationary’s reciprocal – demand must outweigh supply, leading to rising prices. Both paths entail negative ramifications; for instance, deflation is adverse for those paying debts (lower salaries, fixed payments), whereas inflation is adverse for retirees (fixed income, higher prices). Deflation is often considered worse than its counterpart, given that it discourages consumer spending, thus lowering business profitability – a consequence that may eventually spiral into an economic collapse.

The United States has experienced an inflationary history (~2% inflation per year) with regard to the dollar’s value. Japan, a nation that from 1991-2001 was caught in a deflationary storm, is a suitable contrast. Prior to this cycle of deflation, Japan experienced a history of rapid economic growth, growing at a rate of 3.89% (with regard to GDP) compared to the United States’ 3.07% in 1980. By 1990, during Japan’s infamous “Lost Decade”, growth had slowed to a mere 1.14% – an annual incline well below that of similarly industrialized nations. This was largely due to missteps by the Bank of Japan (BoJ – Japan’s central bank) in response to its ongoing real estate and equity bubble. 

Japan has historically facilitated growth by functioning as a net-exporter (via balance of payments and trade surpluses), and thus feared inflation. Concerned about an inflationary horizon, the BoJ slowed Japan’s money supply and increased interest rates, both of which plunged the nation into a liquidity trap. In a liquidity trap, consumers lower spending most often due to deflationary concerns: a caveat which – as aforementioned – could induce economic collapse. To reverse this, a nation must boost the flow of money by increasing monetary supply for consumers and businesses, to thereon encourage spending; Japan accomplished this in 2001, and the impact of sustained deflation was mitigated.

Similar to Japan, the United States – as a result of COVID – has experienced economic disruption. Unemployment soared with over 20 million Americans out of work, and businesses and small shops closed. The result was both a decrease in supply and demand, neither of which explicitly outweighed the other. The U.S. however, has adopted policies similar to that of Japan – seeking to boost consumer spending to offset its earlier market crashes. In providing relief via stimulus grants, and lowering interest rates to historic lows, the United States government and the Fed made consumer borrowing easier than ever. Given that the U.S.’s inflationary history, consumers saw this as an opportunity to spend money now, with the expectation that prices will inevitably increase in the future. There resultantly emerged a boosted flow of money in the United States economy – an end-goal Japan strived to achieve during the Lost Decade. Since demand rose nation-wide due to the aforementioned policies (while many industries still remained depressed – e.g. entertainment), it is evident COVID has produced a current inflationary atmosphere for the U.S. It is important to note this is not fixed, however. With Coronavirus cases once more spiking, the future holds all but a certainty regarding the economic implications of COVID. For now, it is imperative we stay safe and together, work to transition our economy to a pre-pandemic, non-unprecedented state.

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