Goldman Forecasts U.S. Dollar Set for Sharp Decline

 |  Includes: ERO, FXB, FXE, FXF, FXY, GBB, UDN, UUP
by: Edward Harrison

As a result of the Federal Reserve’s next round of quantitative easing, Goldman Sachs is predicting a sharp slump in the US dollar’s value against other major currencies. In particular, the dollar is expected to weaken to $1.79 against the British pound over the next six months, $1.85 over the next year. The dollar will also weaken against the euro to as low as $1.55, according to Goldman. This is far cry from Dollar-euro parity. If the dollar does weaken to these levels, it will likely fan trade friction.

Notable in this discussion is that the all of the adjustment for US dollar currency debasement falls on the floating rate currencies like the euro, the pound, the Swiss franc and the yen. China’s currency, because of its fixed peg to the US dollar, will depreciate as well, setting up tensions with Japan and Europe.

In my view, the best case scenario here is a rebound in bank lending and job growth in the U.S. coupled with a stable housing market. This would limit QE, increase aggregate demand, and reduce trade friction.

In the event that the US economy remains weak and the Fed feels forced to try QE, what can be done to stop the ill effects on trading partners?

  1. Some of this depends on the economy. If the US economy improves at a better than expected rate in 2011, the quantitative easing will subside, halting the dollar’s fall.
  2. The U.S. and China could try to negotiate a maximum rate of US dollar reserve accumulation by the Chinese central bank in order to revalue the Yuan.
  3. The Chinese could move to a basket of currencies peg that would cause the Yuan to automatically revalue vis-a-vis the US dollar if the US dollar falls against the euro and the yen.

Here, I am focused on China, but clearly other bilateral tensions would build. The Swiss, the Canadians, the South Koreans and the Brazilians would find their currencies appreciating more than the euro or sterling for example. Emerging market countries may follow Brazil and South Korea’s examples in erecting capital controls then. But that still leaves a lot of room for trade friction.

Source: Dollar set for sharp decline, Goldman forecasts – Telegraph