Former US Treasury Secretary Connery told foreign Treasury Secretary in 1971: The US dollar is our currency, your problem. After so many years, the ratio of the United States to the world's gross domestic production (GDP) has dropped from 40% in 1960 to less than a quarter. The euro and the Japanese yen have also become international currencies, but the US dollar still dominates the global financial markets, and the international bonds issued by emerging market economies are still denominated in US dollars.
By this dominant position, the dollar exchange rate—the value of other currencies—is obviously a huge impact on the world economy. A newly published research paper by Maurice Obstfeld, professor of economics at the University of California, Berkeley, and Haoonan Zhou, a doctoral student in economics at Princeton University, pointed out that the world is experiencing a wave of US dollar cycles, and the recent rise in the US dollar is unstoppable, which will bring financial and economic pressure to all over the world.
Why is the US dollar so strong? Nobel Prize winner in Economics Kruman pointed out in the New York Times column that there are three mysteries to be solved when thinking about this problem:
1. The dominance of the United States' economic position is no longer as good as before. Why is the dominance of the US dollar still lasting for a long time?
2, why does the fluctuation of the US dollar exchange rate have such a strong global effect?
3, why has the US dollar appreciated so much recently?
The first question is the simplest. The global dominance of the US dollar has a long history, and once this dominance is stable, it will often continue itself. Trading in US dollars is the most convenient and cheapest because most others use US dollars; the cost of borrowing US dollars is usually lower because most world trade is settled in US dollars, while financing costs are low and settlement is encouraged.
Moreover, the developed US financial market allows investors to buy and sell assets easily, which makes the US dollar more convenient and safe when used globally. The total financial markets of euro zone countries are huge, but they seem to be divided. For example, Italian treasury is discounted compared to German treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury treasury The mainland Chinese market is also unreliable, after all, funds entering and leaving the country are still under strict control.
Let’s look at the second question, why does the fluctuation in the US dollar have a huge effect? Obstfeld and Zhou believe that foreign debt in many countries is denominated in US dollars, and the continuous US dollar will cause problems in balance sheets around the world. Kruman believes this argument makes sense, but he still believes that the effect of the US dollar volatility is amazing, especially confused about the strong correlation between the US dollar and the global price of commodities (such as oil and wheat).
We may think that when the US dollar appreciates against the euro, crude oil denominated in US dollars will fall, and oil prices denominated in Euro will rise. But Obstfeld and Zhou found that this was not the case. They found that if the US dollar appreciates by 1%, it will cause a greater decline in the average global commodity price," confirming the results that Kruman has repeatedly observed. When the dollar appreciates against the euro, not only does the oil price in the US dollar fall, but also in the euro.
Therefore, the strong rise in the US dollar helps explain why oil prices are similar to those before Russia invaded Ukraine, and why even the wheat price increase has been greatly retook. These effects are one of the factors that slow down in U.S. inflation, at least for the time being.
As for the third question, why has the US dollar appreciated so much recently? At first glance, the answer seems obvious: the Federal Reserve (Fed) has taken advantage of a series of interest rate hikes to increase the attractiveness of buying dollar assets, and also pushes the dollar up.
But Fed is not the only central bank that raises interest rates. International economists usually believe that the exchange rate is driven by long-term, rather than short-term interest rates, and the long-term interest rate is based on investors' expectations of future prospects. Long-term interest rates in Europe and the United States have risen. The US 10-year Treasury bond yield rose from 1.47% in December 2021 to about 3.26%, an increase of 1.79 percentage points; during the same period, Germany's 10-year yield rate rose from negative 0.38% to 1.67%, an increase of 2.05 percentage points. It seems that Europe's tightening of monetary policy is more effective than the United States, so why is the euro still depreciated?
It is not difficult to imagine possible reasons. The most obvious thing is that Russia's substantial natural gas embargo hit Europe hard and hit the European economic outlook.
Fed policy must consider the problem of beggaring neighbors
No matter what the reason is, it is obvious that the surge in the US dollar has once again brought severe pain to economies around the world, and again, our currency has caused their problems. Should US policies be affected by this?
Former Fed economist and Sam's inventor of the recession indicator, Sam not only strongly criticized Fed's tough anti-inflation approach, but recently called on Fed to have the responsibility to reflect on the pain that its policies have caused to other countries in the world.
Kruman believes Sam makes sense, but he doesn't think Fed will listen at this moment, because Fed officials are still very worried that high inflation may become deeply rooted, and this concern will still override everything unless clear signs show that basic inflation has dropped.
However, Kruman believes that once Fed feels that there is a breathing rest from anti-inflation, it should start taking into account the international impact caused by the strong US dollar. He said: The US dollar may be a problem for other countries, but even if the United States only considers its own interests, it still must live in a world formed by the assistance of our country's policies.
