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The COVID Shock to the Dollar

No country can afford to squander its saving potential – ultimately, the seed-corn of long-term economic growth. That’s true even of the United States, where generations of policymakers have come to regard the long-standing belief in American exceptionalism as though it applied to the laws of economics.

NEW HAVEN – Pandemic time runs at warp speed. That’s true of the COVID-19 infection rate, as well as the unprecedented scientific efforts under way to find a vaccine. It is also true of transformational developments currently playing out in pandemic-affected economies. Just as a lockdown-induced recession brought global economic activity to a virtual standstill in a mere two months, hopes for a V-shaped recovery are premised on an equally quick reopening of shuttered economies.

It may not be so simple. A sudden stop – long associated with capital flight out of emerging markets – often exposes deep-rooted structural problems that can impair economic recovery. It can also spark abrupt asset-price movements in response to the unmasking of long-simmering imbalances.

Such is the case for the pandemic-stricken US economy. The aggressive fiscal response to the COVID-19 shock is not without major consequences. Contrary to the widespread belief that budget deficits don’t matter because near-zero interest rates temper any increases in debt-servicing costs, in the end there is no “magic money” or free lunch. Domestic saving, already depressed, is headed deep into negative territory. This is likely to lead to a record current-account deficit and an outsize plunge in the value of the dollar.

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