The hideous strength of the US dollar

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“It’s our currency, but it’s your problem,” was the 1971 message from John Connally, Richard Nixon’s Treasury Secretary, to American trading partners dismayed by the weak dollar at the time. What was true then remains true now, albeit in the opposite direction, with the greenback rising 6% in April and 13% last year to its highest level in two decades against a basket of major currencies. The Federal Reserve must be aware of the threat posed to global growth by the rapid rise of the American currency.

The greenback is the logical haven for investors seeking financial refuge from a confluence of global shocks that began with the pandemic and were intensified by Russia’s invasion of Ukraine, culminating in a spike in the price of energy and food. The king of the dollar reigns supreme as the Fed maintains a policy of benign neglect in the currency market, having provided nearly unlimited access to dollar liquidity for central banks around the world for the past two years.

With the exception of a handful of outliers, including the Brazilian real and the Peruvian sol, the dollar is omnipotent against almost all currencies of developed and developing countries. This puts pressure on policymakers around the world to defend their currencies or risk importing even more inflation into their already beleaguered economies.

The Fed’s monetary policy is dictated by the needs of the domestic economy. With inflation, the most important element of its mandate, jumping 8.5% in March, the US central bank is expected to follow the quarter-point rise in interest rates in March with increases accelerated by half a point from this week. The futures market anticipates a Fed funds rate of at least 2.5% by the end of the year, against 0.5% currently; the appreciation of the dollar reflects expectations of a shift in the interest rate differential with other countries.

The stronger dollar is also doing the Fed’s job of fighting inflation by tightening financial conditions on a trade-weighted basis. Although the United States is the world’s largest economy and a huge importer of goods, it is relatively insulated from the global energy and food price shock thanks to its domestic production of fuel and food. This also benefits from the fact that all major commodities are denominated in dollars. It’s everyone’s problem if commodities suddenly become more expensive in their respective currencies.

The world has experienced several episodes of too strong or too weak a dollar over the past half-century. The oil price boom of the 1970s led to a global recession, exacerbated by the aggressive rate hikes implemented by Paul Volcker’s Fed. His anti-inflation policies in turn resurrected the dollar in the mid-1980s: the perceived advantage of exporting nations of Japan and Europe over American industry led to the Plaza Accord of 1985, which radically reversed the strength of the dollar and stimulated the American economy. at the expense of other nations, especially Japan.

The current weakness in the currencies of Japan and Europe would generally be welcomed to boost their exports. But the recent slippage of the Chinese yuan, the world’s second trade-weighted currency, puts things in another category. All three regions face an unusual and potentially intractable problem of imported inflation. There is a clear and present danger that rising prices will slow global economic growth as a recession is possible, and stagflation a real risk.

“The rally in the dollar is like an ascending avalanche,” said Kit Juckes, currency strategist at Societe Generale SA. “Just as an avalanche picks up snow, rocks, trees and everything in its path as it rolls down a mountain, so the rising dollar has the effect of causing a larger number of currencies. A broad-based move, however, is tightening global monetary conditions, and thus downside economic risks are increasing.

At some point this will start to affect the US economy and become relevant to Fed decision-making, but it could take some time. Of course, US gross domestic product surprised on the downside, shrinking at an annualized rate of 1.4% in the first quarter. But that was due to a surge in net imports, no doubt helped by the added purchasing power of a stronger dollar, combined with a slump in exports.

With the Fed’s balance sheet still at nearly $9 trillion, there are plenty of dollars floating around. The central bank is expected to begin actively selling its bonds, possibly as early as this summer, which could reduce overall liquidity and, unexpectedly, make the dollar less of a safe haven. Fewer dollars should in theory increase its value, but the world needs to become a better and safer place before the greenback’s bullish trend returns significantly. For the sake of the global economy, let’s hope the crown of the dollar king begins to slide.

More from Bloomberg Opinion:

• Looking for the bright side of GDP contraction: John Authers

• More infrastructure stimulus is the last thing China needs: David Fickling

• The ECB must act to avoid a monetary crisis: Marcus Ashworth

This column does not necessarily reflect the opinion of the Editorial Board or of Bloomberg LP and its owners.

Marcus Ashworth is a Bloomberg Opinion columnist covering European markets. He spent three decades in banking, most recently as Chief Market Strategist at Haitong Securities in London.

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