According to Xinhua Finance, during the North American trading session on July 12, the euro fell 1.5% against the US dollar to the level of 1.0032, only a line away from parity.

euro and dollar notes. Photo/Xinhua News Agency

According to Xinhua Finance , during the North American trading session on July 12, the euro fell 1.5% against the US dollar to the level of 1.0032, only a line away from parity. The last time the euro reached this low against the dollar was 20 years ago in 2002. This also means that since the euro officially entered the market, the exchange rate against the US dollar has achieved a "cycle" from appreciation to depreciation. The depreciation of the euro and the appreciation of the US dollar are the reasons for the combined effects of long-term and short-term factors, and will also have a huge and far-reaching impact on the world.

USD hike rate led to a rapid depreciation of the euro

Euro was once placed in great hopes by the outside world. It was not only considered a powerful driving force for promoting internal economic integration of EU , but also once considered the currency that is most likely to challenge the hegemony of the US dollar. The euro issued by

based on common treaties and regulations will theoretically conduct market operations strictly based on key indicators such as inflation rate, employment rate and economic growth rate of the euro zone, so it seems to be more strict and cautious in issuance than the US dollar. Compared with the often "indiscriminate" US dollar, the euro should have more reliable international credibility and potential as a hegemonic currency.

But the reality is that since the advent of the euro, after a decade of appreciation, it has begun to depreciate continuously. Over the past decade, the euro-USD exchange rate has depreciated by nearly 40% from its highest point. Overall, although the euro has formed the biggest potential challenge to the hegemony of the US dollar in the international capital market, 20 years have passed and it is still only a potential challenge.

The direct reason for the rapid depreciation of the euro in the past year comes from the expectation of a rate hike in the US dollar .

html, on July 11, the Euro Group Conference was held in Brussels, Belgium. Photo/Xinhua News Agency

In 2020, in order to cope with the economic crisis caused by the new crown epidemic, the government launched a huge amount of relief funds, so that the number of paper money printed that year once accounted for 20% of the total US dollar circulation in the market, which led to a rapid rise in the US inflation rate in 2021, increasing from less than 2% to 8.6% in a year.

At the same time, the market expectations of the Federal Reserve's interest rate hike in have been strengthening since 2021 and finally became a reality in early 2022. On March 17, the Federal Reserve of announced that it would raise the benchmark interest rate by 25 basis points to the range of 0.25%-0.5%. This is the first rate hike by the Federal Reserve since December 2018, and it has also started a cycle of US dollar interest rate hikes. In June, it directly announced a sharp rate hike of 75 basis points, raising the target range of the federal funds rate to 1.5%-1.75%. This is the largest single rate hike from the Federal Reserve since 1994.

At the same time, the Federal Reserve announced plans to reduce its balance sheet of $8.9 trillion, starting on June 1, shrinking the balance sheet at a monthly pace of $47.5 billion, and gradually increasing the balance sheet to $95 billion per month within three months.

rate hike and balance sheet reduction both mean that the huge amount of US dollars will exit the market. This will inevitably lead to a shortage of US dollars in the market, causing exchange rate fluctuations to appreciate in US dollars.

The violent geopolitical turmoil is mainly due to

If the market does not need the US dollar, or the euro needs even more, then the Fed's interest rate hike and balance sheet reduction do not necessarily mean the appreciation of the US dollar and the depreciation of the euro. But the current exchange rate performance means that the market demand for the US dollar is still strong, and demand for the euro is relatively weak.

The current violent geopolitical turmoil is the main reason for this phenomenon.

The Russian-Ukrainian conflict has undermined European countries' expectations for a future of regional strategic stability and prosperity. On the one hand, the US dollar, which has a strong military force protection, has become a more popular safe-haven currency in the capital market. The rising prices of commodities such as oil and grain have further intensified the market demand for the US dollar.

On the other hand, Europe's renewed emphasis on defense issues has also suppressed expectations of the euro's appreciation. For example, Germany announced an additional 100 billion euros of special funds, and increased the annual military expenditure to more than 2% of the total GDP of from the original 1.53% to more than 2%. In the future, European countries are likely to increase defense expenditure accordingly, which greatly increases the market's expectations for the euro depreciation.Because, if the European Central Bank also raises interest rates, it will greatly increase the borrowing costs of member countries and even destroy the eurozone economy that has finally escaped the subprime mortgage crisis.

The unified currency, but the inconsistent fiscal policy, makes the EU member states' ability to withstand the euro interest rate hikes is huge. So, although inflation in the euro zone is also increasing, market expectations for the ECB rate hike have fallen.

European Central Bank Headquarters Building. Xinhua News Agency reporter Shan Weiyi Photo by

The appreciation of the US dollar has a huge impact on

In fact, in the past year, not only the euro has depreciated compared with the US dollar. Currencies such as the pound, yen, Swiss francs have shown the same trend, which means that all countries cannot afford the negative effects of interest rate hikes on economic development.

At present, not only the euro depreciates, but the appreciation of the US dollar has also had a huge impact on other countries. The first thing to bear is that global trade growth will be curbed. In the current global trading system, the US dollar is the most important circulating and settlement currency. The appreciation of the US dollar will lead to a decline in the purchasing power of non-US dollar currencies. Countries that are highly dependent on global trade will become "poor", and global economic development will also encounter setbacks.

In addition, the appreciation of the US dollar will increase the cost of debt in US dollars, causing countries with US dollar debt to fall into a credit crisis where they cannot repay their debts on time. For low-income countries, the ability to buy USD to repay debt has dropped sharply, resulting in sovereign debt defaults and national bankruptcy, such as Sri Lanka .

Third, the appreciation of the US dollar will lead to the return of the global dollar to the United States, further urging domestic inflation in other countries. Under the premise that commodity prices have soared, currency depreciation will undoubtedly become a powerful driving force for further driving high inflation.

Finally, the appreciation of the US dollar may exacerbate political turmoil in some regions. In the early 1980s, in order to cope with inflation, the dollar appreciated by nearly 80%, and the regimes in many countries collapsed under internal and external difficulties.

If the Fed's rate hike pace continues to advance at such a radical pace, then the development of the global economy will face major challenges in the future, and it can be foreseeable that large-scale turmoil will occur in the political situation of many countries.

Written by / Liang Yabin (Professor of the Central Party School International Strategy Institute)

Edited by / Liu Yunyun

Proofreading / Liu Yue