About U.S. Dollar
1. What drives the dollar
2. Is the dollar a problem today
3. Will the dollar ever weaken? Three conditions for that
4. Let’s sum things up
While the U.S. Dollar Index, aka DXY, is at a 20-year high, The Economist has come out with an exciting article on why the dollar is strong and why that’s a problem. Let’s see what it comes down to, in a nutshell.
What drives the dollar
1. Actually, a stronger dollar reflects changes in the U.S. monetary policy. At the beginning of the year, the Fed began to fight inflation adamantly. Since then, the rate hikes—and we’re expecting more to come—have turned the dollar into a highly profitable currency. High interest rates are magnets for global capital, which, in turn, makes the dollar even more stable.
2. The dollar is a safe haven during hardships: frightened investors usually switch to foreign currencies. High oil and gas prices are mostly harmful to energy importers (Europe) but beneficial to exporters (USA). The currencies, which have kept up with or outperformed the dollar this year, tend to be those of energy-producing countries.
3. The U.S. is a reliable driver of economic growth (but I think it’s debatable), and that’s super true now. Europe is likely to face a recession. The closely watched Purchasing Managers’ Index proves that the eurozone economy shrank in August.
4. Less noticeable is Asia stagnating as well. Export growth has declined, and the latest worry is for China’s economy, as we see its viability has been affected by real estate and zero-COVID policies. The entire Asia region is slowing down. South Korea, Taiwan, and Japan have seen their industrial production fall sharply in July. Exports have decreased, for real. High energy prices aren’t helping. The currencies of these countries are performing worse than the dollar. In Japan, where the central bank offers ultra-low interest rates, the authorities are hinting at intervention to make JPY stop falling. China is back to supporting CNY.
Is the dollar a problem today
1. Well, a stronger dollar is the cure for unbalanced growth, as it gives European and Asian exporters an advantage over domestic producers in a stronger U.S. market.
2. In practice, a stronger dollar makes things worse: it squeezes global credit, as countries and companies outside the U.S. borrow in $$$. For that reason, when the dollar rises, it becomes more expensive to pay back debts out of local-currency revenues. For many emerging-market countries, the higher cost of dollar borrowing outweighs the boost to exports they get from a weaker currency.
3. Dollar strength is no good for rich countries either. Exporters in Europe are suffering from energy disruptions and can’t take full competitive advantage of a favorable exchange rate.
Will the dollar ever weaken? Three conditions for that
1. First and foremost, the global growth gap has to become narrower. A hard landing in the U.S. won’t be the magic formula. A synchronized decline in all regions worldwide would only cause a run to the safety of the dollar (although JPY might catch a bid). Growth prospects outside the U.S. have to improve.
2. Second, it’s a sharp reduction in price and wage pressures in the U.S. This way, the Fed eases off the monetary brake, leaving the dollar out of some yield support.
3. The third one is related to the first two: a weaker dollar requires positive news on global energy. In other cases, it’s unlikely we can see Europe closing the growth gap with America.
Let’s sum things up
None of these conditions are likely to be met shortly. And until they are, the dollar will stand strong—but only because JPY, EUR, and other currencies are so feeble.