Dollar demand is pushing the US currency far above its intrinsic value, increasing the risk of market volatility. Progress in developing novel coronavirus vaccines in the United States is raising expectations for a quick recovery in the world’s largest economy, boosting demand for the greenback as it is expected the vaccination will help the opening of the economies.
According to the Nikkei equilibrium exchange rate, determined by Nikkei Inc. and the Japan Center for Economic Research, the dollar could be losing value because of the US economy’s growing government debt. The main aspects that the Nikkei EER is focused on are the economic fundamentals of a region are the most crucial ones, such as government debt and current account balance.
The disparity between the potential and real prices of the currency would inevitably result in a reaction. The world economy, which has been struck hard by the coronavirus pandemic, could be shaken if the dollar weakens quickly. The dollar was trading at 108 yen on April 16, 14 yen more than the Nikkei equilibrium exchange rate, or theoretical value, of the US currency against the Japanese currency, which was at 94 yen. In general, the currency of a nation with high government debt and a significant current-account deficit loses value relative to other currencies.
Between October and December 2020, the dollar’s Nikkei EER against the yen was 94 yen, relative to 110 yen between October and December 2019, before the coronavirus epidemic spread. Over the pandemic, the United States moved to shore up its faltering economy with huge monetary expenditures, resulting in an increase in government debt. If you were trading currencies online with Brokers or your own, around the fourth quarter of 2019 and the same quarter of 2020, the dollar’s Nikkei EER versus the yen changed by 16 yen, implying that the greenback lost 16 yen in value.
Furthermore, considering the United States’ future fiscal investment, the dollar’s Nikkei EER against the yen would eventually fall. The administration of President Joe Biden has also announced a $2 trillion stimulus plan and is exploring infrastructure spending. It is highly anticipated that the US government’s deficit will escalate if the administration struggles to find revenue, even by tax increases.
Since personal consumption in the United States is rapidly recovering, the country’s trade deficit may widen as a result of increased imports. The dollar’s downward trajectory is expected to persist in theory. The dollar’s exchange rate, on the other hand, is going in the reverse direction. At the end of 2020, the dollar was valued at 103 yen, but by the end of March, it had risen to almost 111 yen, the highest amount in nearly a year.
The resilience of the dollar in currency markets represents investor trust in the US economy. According to the International Monetary Fund, the US economy will rise at a rate of 6.4 percent in 2021, the fastest in 37 years and far more than the rest of the world. The disparity in the theoretical and real value of the currency was still visible in the aftermath of the global financial crisis in 2008. In currency markets, the dollar later fell in line with its theoretical value. The US government’s debt was rising at the time to deal with the global financial crisis. It is now rising once more. Year on year, government debt as a percentage of gross domestic product increased by 13 percentage points in 2009 and 19 percentage points in 2020.
The “twin deficits” of the United States have also been factored in by capital markets in the past, allowing a stronger dollar to be corrected, according to Tsuyoshi Ueno of Japan’s NLI Research Institute. If the dollar continues to rise, certain developing economies with dollar-denominated loans will face higher repayment obligations. Brazil’s and Turkey’s central banks have both lifted interest rates. The strengthening of the dollar is a challenge to the global economy because it raises questions about debt in developing economies.
Summing It Up
Finally, to sum up, it’s unclear how long the government-assisted economic rebound in the United States will last. If the economy loses momentum, the market will turn to the dollar’s actual strength. If the dollar depreciates at a faster rate than its theoretical value, caution would be needed. Financial markets will be rattled if the currency depreciates and prices escalate in lockstep, implying that monetary policy may remain unchanged. The dollar’s movement should be closely monitored, as it serves as a litmus test for the global economy in the post-coronavirus period.