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The decline in domestic saving in the U.S. and its “squandered global leadership” have put the U.S. dollar under pressure, says former Morgan Stanley Asia chairman Stephen Roach. He predicts the broad dollar index will drop by 35% and foresees legitimate challenges to the greenback’s status as the world’s dominant reserve currency.
“There are plenty of alternatives,” said Roach, who’s now a senior fellow and lecturer at Yale University and considered a top authority on Asia and currency matters. The passing of the European Union’s 750 billion euro coronavirus recovery fund and a sovereign pan-European bond could boost the euro, he says.
The Chinese yuan could be another U.S. dollar alternative if China “stays the course on reforms,” said Roach. The idea of there being “no alternative to the dollar” is being tested by the ongoing pandemic, he said.
In an Eastworld Spotlight conversation with Fortune’s Clay Chandler this week, Roach discussed U.S. dollar alternatives, the future of U.S.-China relations, and how a President Joe Biden would treat Beijing. The conversation below has been edited for length and clarity.
Fortune: You’ve been warning for nearly a month that the dollar is in danger. Talk to us about the outlook and the sources of your concerns.
Stephen Roach: The dollar has had a strong run since 2011; a broad dollar index up close to 30% in inflation-adjusted terms. Over the next couple of years, I think the dollar is going to undergo a sharp correction to the downside. I look for the broad dollar index to decline by 35% on an inflation-adjusted basis for two sets of reasons.
One, the U.S. macro imbalances are going to be building as never before. A sharp decline in domestic savings that will trigger a record current account deficit. We entered the pandemic with a very low domestic savings rate, 1.4% of national income. And courtesy of these gigantic budget deficits, we’re going to see a negative savings rate to the tune of –5% to –10%.
The second set of reasons behind the dollar call is that America has squandered its global leadership in so many ways—de-globalization, decoupling, a trade war, trade protectionism. We’ve had an unbelievably abysmal performance in addressing the coronavirus relative to other nations, and we have a racial catharsis going on in the United States.
So from both standpoints…the dollar headed down 35% is not unprecedented. We had a comparable decline in the 1970s, a comparable decline for a couple of years in the mid-’80s, and about a 30% decline in the early 2000s. We’re going to have another one, it’s long overdue. It’s 35%—it’s a sharp decline.
Are we going to have an alternative to the U.S. dollar?
There are plenty of alternatives, [and] the most unloved [and undervalued] major currency in the world right now is the euro. [The euro has] been moving up recently, and if European political leaders can get their act together and pass this package that funds a 750 billion euro Next Generation EU recovery plan, and endorses the issuance of a sovereign pan-European bond to go along with it, the euro will continue to move up sharply. [Editor’s note: The interview was conducted before EU leaders preliminarily passed the recovery fund on Tuesday.]
I think the Chinese renminbi can also continue to move up on a broad trade-weighted basis. It’s up about 50% over the last 15 years, [and there’s more to go] if China stays the course on reform. I’m not recommending…exotic alternatives, but you have to look seriously at cryptocurrencies like Bitcoin and precious metals like gold.
So I think the idea that there’s no alternative to the dollar is really going to be tested during this COVID crisis.
What are the additional reforms needed for China to play a bigger role as a reserve currency?
Three things in particular that are really critical: state-owned enterprise reform, where the progress has been very disappointing. Capital market reforms—an ongoing process [that has] slowed down; more needs to be done, especially in the area of currency and capital market convertibility. And thirdly, as glaringly pointed out by the coronavirus, [China’s] social safety net is still porous and much more needs to be done to invest in retirement and in health care infrastructure.
The Trump administration seems determined to prevent China from getting a hold of cutting-edge Western technologies and has reached out to other U.S. allies to join the effort to keep China out of the global techno ecosystem. Can the U.S. succeed in slowing the pace of innovation in China or even shut it down?
I don’t think [the effort] could shut it down, but it certainly can have an adverse impact. The Trump administration’s move on Huawei and its suppliers is something to be [taken] very seriously.
The U.S. has a view that China is a threat and should be contained from achieving the type of technological dominance that America has long enjoyed post–World War II. And I think this technology battle is really at the heart of what could well be a “Cold War 2.0.”
Given all the other turmoil in the U.S. economy right now, is the focus on the U.S.-China trade deal a thing of the past, or is it still something that’s important to how markets perform?
COVID-19 has taken over where the trade issues have left off [and] has clearly taken the upper hand to a large extent. Investors have pretty much come to the view that phase 1 didn’t really accomplish much and that the likelihood of a phase 2 is very low. And with Vice President Biden leading so soundly in the polls, the prospects of a new reset or a new framework to negotiate these trade issues is something that investors will have to take into consideration in shaping their market outlook.
The markets are done with the trade war for the time being, and this is very much at odds with Republicans’ and the Trump administration’s strategy to fixate on China to deflect attention away from their pathetically horrible performance in dealing with the coronavirus.
In the case of a Biden victory, do you see a significant reset on how the U.S. deals with China?
There will be greater predictability to do policy. There are a lot of tough issues that have been put on the table in the last two and a half years that are not going to be yanked off the table. You are going to see a very different approach, one that doesn’t cave to China but really focuses much more on finding common ground through compromise, rather than utilizing the so-called Art of the Deal strategy to punish and bully a supposed economic adversary as the Trump administration has done.
On the structural issues of technology transfer, innovation policy, intellectual property rights, and cyber, I think if [Biden] is elected, he will be very tough on those issues. But I think it’ll be a process that will be easier to understand, [and] more transparent in its objectives and its tactics.
This story is part of Eastworld Spotlight, a series of conversations on matters of business, tech, and finance with executives, experts, entrepreneurs, and investors in Asia. Subscribe to Fortune’s Eastworld newsletter to get them in your inbox.