ADRIAN SAVILLE: Are the almighty dollar’s days numbered?

Economists seldom agree. But when it comes to the waves of consumer price inflation washing over the world, head scratching and economic double speak have been replaced by consensus finger pointing.

The agreed view is that surging price inflation is caused by Russian president Vladimir Putin’s war in Ukraine. 

The consensus runs something like this: around the world consumer price inflation is at (or close to) multidecade highs. This is especially true of advanced markets: 8.3% in the US, 9.1% in the eurozone, and 10.1% in the UK. Even Japan’s wholesale price inflation sits at 9% — an eye-watering figure for a country that has experienced falling prices since the mid-1990s.

In explaining inflation, the consensus identifies various inciters. Choked supply chains, port blockages, second-hand car prices and microprocessor shortages all are given walk-on parts in the inflation act. But according to the established view the main culprit is Putin’s war, which has driven food and fuel prices sharply higher. The agreed view goes on to suggest that if energy prices were to reverse — or if war had never happened — we would be free of inflation.

In four short words: this argument is wrong. Amid furious finger pointing, the argument ignores the actual star of the show — the wild printing of money by many central banks, particularly the US Federal Reserve.

Dazed, confused and captivated

The irony is that the very people seeking protection from inflation are embracing the root cause: the dollar. Something akin to a global Stockholm syndrome appears to be playing out as the greenback has surged to 30- and 40-year highs against the yen and sterling, and reached parity with the euro. This seems a bizarre outcome given that the Fed’s actions have grown the quantity of US dollars by 38% since early 2020, an amount equivalent to printing the economies of Mexico, Switzerland and Spain out of thin air — twice.

The root of the problem

The ballooning money supply considered against the consensus view has led experienced fund manager Tim Price to wonder if “everything we are told about inflation is a lie”. Perhaps Putin triggered inflation. But if money causes inflation, it is hard — maybe impossible — to escape the argument that the reason for our current global conundrum is the wild printing of money, specifically by the Fed. Could it be that the world’s most loved currency might not be coated with as much Teflon as euro parity suggests?

The criteria for sound money are that a currency is trusted, regarded as a store of value, widely accepted as a medium of exchange, and considered to be a stable unit of account. In addition, the monetary authority behind the currency must be seen to manage it prudently. This speaks to growing money supply in line with — or perhaps modestly ahead of — the growth structure of the economy.

With the US population growing 0.5% a year, and productivity growth running at about 1% per year, the pace at which money supply should be growing is about 1.5% per year. Actual growth in money supply is about 10 times this rate. Even if the Fed was overly zealous during the pandemic, as The Economist concludes, it seems the Fed is producing “almost the opposite of what good monetary policy is supposed to achieve”.

Stop the presses! Or not?

The printing of US dollars comes with at least two further issues of concern for investors. The first is that to support strong structural growth a country needs a high investment rate. Yet gross fixed capital formation in the US averages five percentage points below the world figure of 25% over the past decade. This means the printing of money has facilitated consumption, not investment.

The second is that printing money has happened alongside a steady ramp up in debt-to-GDP ratios. The US debt-to-GDP ratio stands at 124% — far above critical threshold levels identified by Carmen Reinhart and Kenneth Rogoff in their seminal work on sovereign default.

Diversification in currencies

While it would be bold to suggest that the greenback will fall from its established place as the world’s reserve currency, a more considered approach for responding to the current conundrum might be to recognise the faults in the US dollar and look for the merit in other currencies. These might include the less widely held — but structurally stronger — South Korean won, the Singaporean dollar, perhaps even digital currencies, and, yes, gold.

Sentiment should play no part in this determination. After all, the dollar would not be the first dominant global currency whose number was eventually up. Just ask Britain which, for more than a century years (1815-1920), held the world’s reserve currency — or France (1720-1815) or the Netherlands (1640-1720). We also need to consider that if diversification is the only free lunch in investing, then the principle should apply as much to currencies as it does to other denominations of investing, including asset classes and industries.

It is a rare circumstance when economists agree. When it comes to the waves of inflation washing over the world, it would be a coincidence inside a coincidence if, in agreeing, economists were also right. Since the 1980s Prof Steven Wilkinson has been suggesting that the world is playing a double-or-quits game. He may be right. Perhaps we are close to peak US dollar. Perhaps the buck stops here.

• Dr Saville is an investment specialist at Genera Capital and professor at the Gordon Institute of Business Science.