The weakening euro, the Chinese yuan losing its feathers, the British pound falling, the yen plunging: the dollar king reigns supreme and panics the markets. After years of truce, a new kind of currency war is in full swing.
The dollar? “It’s our currency, but your problem.” The famous phrase uttered one fine day in 1971 by Richard Nixon’s Treasury Secretary, John Connally, has not aged a bit. Fifty-one years later, it is even more than topical.
The dollar? “It’s our currency, but your problem.” The famous phrase uttered one fine day in 1971 by Richard Nixon’s Treasury Secretary, John Connally, has not aged a bit. Fifty-one years later, it is even more than topical. Since the start of the year, the dollar has indeed continued to give headaches to other currencies. The Indian rupee thus posted a decline of 10% against the greenback, the Chinese yuan fell by 12% and the euro weakened by 15%. It’s even worse for the British pound which lost 17% and the Swedish krona 20%. As for the Japanese yen, it has plummeted by 25% against the dollar since January. Why so much turmoil after several years of dead calm? Two factors explain this spectacular rise of the dollar against the currencies of developed countries. The first is the safe haven status of the dollar, which appreciates when economic uncertainty increases. And all the specialists will tell you: “This is certainly the case today”, confirms Koen De Leus, chief economist at BNP Paribas Fortis. With the war in Ukraine, inflation eroding consumers’ purchasing power, zero covid in China and the slowdown in European growth, the economic weather is far from bright in October 2022. Admittedly , no offense to the Cassandres, “the worst is not always certain”. But in the meantime, the world is rushing to the dollar. And so, as we will have understood, this one benefits from it. He also benefits all the more because, as Bruno Colmant recently underlined interviewed by Trends-Tendances, “the United States is not affected in the same way by the repercussions of the war in Ukraine”. And this, unlike the countries of the euro zone which are very dependent on Russian gas and which, in addition, suffer from their geographical proximity to the conflict. To the point for the European currency to now evolve below its parity threshold with the greenback. Unheard of since the introduction of the euro in 2002. In addition to this aspect of refuge, the second factor which explains the sustained rise in the dollar is the voluntarist policy of the Fed (the American central bank). Determined to fight inflation at all costs, it has raised its key rates very sharply in recent months. To cool the American machine, it abruptly raised its rates by 3%, thus causing upward pressure on the dollar and downward pressure on many other currencies. This interest rate difference is even, according to Koen De Leus, “the essential element” which plays in the current strengthening of the dollar. With lower inflation and higher interest rates in the United States than in the euro zone, investors are logically flocking to investments in dollars, which are more attractive in terms of real interest. Let’s not forget either that, “in an inflationary world, it is in your interest to have the strongest currency possible, adds Philippe Ledent, economist at ING in Belgium. This makes it possible to import less inflation by stabilizing the price of what is bought abroad. Conversely, having a weak currency is today a handicap since imported products are more expensive”. It is indeed difficult to ignore the role of a weak euro in the crisis affecting Europeans. While the all-new iPhone 14 doesn’t cost more than its previous version in the US, it’s priced much higher here. And of course, let’s not talk about the price of gas… After years of dead calm, are we therefore witnessing a new currency war? For Koen De Leus, the answer is yes. “All the central banks of the developed countries are forced to line up to defend the value of their currency against the dollar in order to limit the cost of imports and the extent of the rise in prices. But this is not a war of classic currencies which aims to make the products you export more competitive thanks to a currency that is not too strong: it is a reverse war. The strengthening of the dollar is a way for the United States to reduce imported inflation, says the Fed In my view, this is not really necessary as imports represent only 12% of the American GDP and, in addition, 95% of goods of a global nature are denominated in dollars.” At ING, Philippe Ledent is of the same opinion: “It is true that the Fed is very aggressive in tightening its monetary policy and is forcing others to follow. It is moreover so aggressive that China and Europe “are not in a position to retaliate. The ECB does not have the capacity given the economic context in the euro zone while China is mired in its zero covid policy and its real estate problems. The Fed is clearly going it alone”. But “it first pursues an internal objective, continues Philippe Ledent. It is not strictly speaking an open war”. Maybe, but central bankers know that the speed with which they raise or lower interest rates has a big impact on the exchange rate. Even the Swiss central bank (the SNB), known for trying to manipulate its currency, has changed its tune. While it usually tries to weaken a generally overvalued Swiss franc because it inspires confidence, it is now doing the opposite: it is trying to keep it high against the dollar. In other words, we are a long way from the years of negative rates and competitive depreciations after the financial crisis, which were aimed at boosting consumption and encouraging exports. Whether the dollar’s current strength is here to stay remains to be seen. For Philippe Ledent, having a strong currency is not a problem for the United States. “The dollar is the international reserve currency. It is what allows the United States to be the policeman of the world, in addition to being a factor of economic independence. The American economy is not based on foreign trade but in a huge domestic market. Business competitiveness is less of an issue for the United States than for Germany or Belgium.” Admittedly, “but a dollar that is too strong can lead to a deceleration in global growth when it is already very fragile”, indicates Koen De Leus. “Some studies show that a 10% appreciation of the dollar reduces growth in emerging countries by 1.5% and that a one percent appreciation of the dollar reduces the volume of trade in the rest of the world by almost as much .” Last but not least, concludes the economist, “the dollar has gained more than 20% since mid-2021 against the currencies of developed countries, equaling or exceeding the increases that have accompanied the last seven major global financial crises, from the crisis from the Latin American debt of the early 1990s to the debacle of 2008 to the bursting of the dotcom bubble in 2001”. Way of saying that a dollar that is too strong is also the problem of the Americans.