The gyrations of the US dollar took centre stage in the financial markets last week, especially when US Treasury secretary Steven Mnuchin appeared to differ with President Donald Trump on the administration’s short and long-term objectives for the currency. In a highly unusual development, European Central Bank president Mario Draghi added to the turmoil by admonishing the US administration for breaching the spirit of recent international agreements on currency manipulation.
Political squalls of this kind can certainly disrupt the calm of currency markets, and in the past they have sometimes threatened international market confidence in a dramatic manner. But the latest bout of dollar weakness is nothing new — the world’s reserve currency has now been falling fairly steadily for about a year, and almost every other currency has strengthened against it. Since this period of weakness represents a big change of direction compared with the robust rise in the dollar’s value from 2011-17, something fundamental must have changed.
Normally, the first place to look when a currency changes direction is relative monetary policy. But this time, this does not seem to provide a ready explanation for the dollar’s weakness. In fact, on the surface, it raises a puzzle that has been widely discussed by economic commentators.