The world has many currencies, but one dominates the others: The US Dollar. Although a unified currency could be more effective in today’s global economy, and avoid exchange rate fluctuations that can destabilize an economy, it will not likely happen any time soon.
The “will the dollar collapse” is a question that has been on many people’s minds lately. The US dollar has been in decline since 2002 and inflation has not been as high as it was before.
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The Federal Reserve and other central banks are attempting the most delicate of maneuvers: a gentle landing, in which inflation is brought down to earth without smashing the economy into recession. What is the risk? Instead, they’ll crash to a halt on the hard concrete of a rising dollar.
With the exception of this newspaper’s editorial section, the dollar’s extraordinary rise in recent months is the largest business and economic story that is practically nowhere to be found in the business and economic press. The dollar has surged over 20% against the Japanese yen to a 20-year high, and 13% against the euro to a two-year high, compared to its lowest position in the previous 12 months. The dollar has climbed to roughly $1.08 per euro, up from $1.22 a year ago, and the term “parity” is beginning to crop up in certain conversations.
The narrative is frequently packaged as the other currency’s weakness, while the underlying story is the dollar’s strength. Because the Federal Reserve seems to be tightening more forcefully than any of its major counterparts, investors are flocking to the greenback. The concern, and by far the most serious threat to the Fed’s goal of a gentle landing, is that exchange-rate volatility would stifle the economy on Main Street, first overseas and later at home. Currency mismatch, or the buildup of assets or liabilities in one currency while the things that matter to a corporation (revenues, book value, and the like) are denominated in another, will be the throttling mechanism.
In the financial system, offshore claims denominated in dollars have increased by 60% in the last 15 years. According to the Bank for International Settlements, the value of these credit agreements has climbed from $6.9 trillion in mid-2007 to $11.1 trillion in the third quarter of 2021, up from $6.9 trillion in mid-2007. Add in another $2.9 trillion in dollar-denominated loans granted to international borrowers by U.S.-based banks, and you’ve got a mountain of debt that’s becoming more difficult to repay in local currency as the dollar rises.
It’s quite difficult to pinpoint the purpose of all this currency borrowing. Prior to the pandemic, research suggested that foreign-listed firms may have borrowed dollars to store cash in a carry trade, counting on low U.S. interest rates and a weakening currency to produce profits as their native currencies strengthened. What if the trend in the exchange rate reverses? We’ve seen this scenario play out in multiple financial crises throughout the years.
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Meanwhile, internal trends in nations coping with local-currency decline relative to the dollar pose a challenge to the soft-landing fantasy. We’re talking about you, Japan. As the yen approaches 130 per dollar (it’s now at 128, with a higher figure indicating a weaker yen), Tokyo is finally understanding that the old adage that a weak currency boosts an export-dependent economy is no longer true.
This is partly due to the fact that more complicated supply networks muddle the impact of a bilateral currency change. Japan, like the majority of industrial exporters, is now merely one link in a lengthy global production chain. Part of this is due to the fact that the world’s third-largest economy is no longer the exporting behemoth it once was. It has grown reliant on foreign imports of energy and other things. At this point, stifle whatever trade-warring joy you may be feeling from the 1980s. Under no circumstances is a more weakened Japan beneficial to the American economy.
Europe may be forced to learn a similar lesson in the near future. A weakened euro, according to conventional thinking, was beneficial to Germany, Europe’s export engine. Is this still the case? Energy, both in terms of cost and possible shortage, is the biggest danger to Germany’s economy today. A recession is inevitable if people elect to embrace a Russian gas embargo for political reasons. Paying more devalued euros for energy imports purchased in dollars from other sources would further worsen and prolong the crisis.
The United States has weathered several recessions across the globe, and this one may be no different. But how fortunate are we, given Washington’s ongoing opposition to constructive corporate investment and consumers’ mounting dissatisfaction with inflation?
Jerome Powell, the chairman of the Federal Reserve, has no option but to keep tightening. Given the way inflation robs families and makes it hard to allocate investment effectively, runaway inflation is the one disease that may cause even more damage than the dollar’s unchecked increase in value. However, skillful demand management in the US economy through accurate use of the monetary brake is just half of the equation when it comes to delivering a gentle landing. It’s possible that we’ll come to regret the day when global monetary and exchange-rate coordination went out of style.
Former Trump economics director Kevin Hassett is interviewed by Paul Gigot for the Journal Editorial Report. Images courtesy of Getty Images Mark Kelly’s composite
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The print issue of the April 22, 2022, was published.
