America’s strange sweetheart position in the global economy
The British economy is collapsing and the pound is collapsing. The US economy is faltering and the dollar is strengthening.
Indeed, the dollar is as strong as it has been for a generation. This year, it has appreciated by around 16% against the euro, 21% against the pound and 30% against the yen. It has also appreciated considerably against the currencies of a number of low-income countries. It’s not because the United States is doing well on its own, but because it occupies a strange position in the global economy, a position that should become softer as the world teeters on the brink again. of the recession.
A few factors led the United States to experience an unprecedented rise in the dollar, making imports cheap for American consumers. On the one hand, the US economy has its problems. The Fed’s aggressive efforts to control inflation could end up triggering a recession. The construction pipeline is freezing, a number of local real estate markets are experiencing significant corrections, and consumers are starting to pull back. Yet the United States, which has low unemployment, remains strong relative to its peers.
Europe, on the other hand, has higher inflation rates, as the continent grapples with a brutal energy crisis and the deep fallout from Russia’s invasion of Ukraine. And many countries within it are facing their own particular struggles: Britain, for example, has suffered amid chaotic government, unstable financial markets, horrific budget plans and a disaster at the cost of life raging, problems only made worse by Brexit – no wonder investors are abandoning pound denominated investments.
Developing countries do not fare much better. China’s zero-COVID policy has saved lives but hampered its economy, which the World Bank says is expected to grow by less than 3% in 2022, half or a third of normal. China’s real estate sector is also collapsing. Many other countries are grappling with high commodity prices and fuel shortages. The strong dollar makes prices even higher, as countries in some cases have to import food and other goods denominated in dollars.
Investors around the world see the global economy stumble. So they flee to safety, that is to say, to investments in the United States, which drives up the value of the dollar even more. “The impact of the Russian-Ukrainian war is weighing heavily on Europe’s outlook, while COVID-19-related shutdowns in China and a weak housing market are dampening growth in Asia,” said Kathy Jones, strategist in Asia. head of fixed income at the Schwab Center. for financial research at Charles Schwab. “Even with recent weak GDP growth, the United States still looks better positioned to weather a global economic downturn.”
At the same time that the Fed’s interest rate hikes have slowed the US economy, they have also made Treasuries more lucrative for short-term investors. A variety of other factors are dampening interest in US government debt, which has profound implications for Washington’s finances and the future functioning of the global financial system. But for now, Washington offers higher interest rates than Brussels, London or Seoul.
These factors have only increased the strength of the dollar for a long time due to its unusual role in international finance. Many products are quoted in dollars. Many foreign central banks choose to hold dollars as reserves. Many international commercial contracts are executed in dollars. This creates a lot of demand for dollars, all the time. And as senior International Monetary Fund official Gita Gopinath and former Fed economist Jeremy Stein have shown, these financial realities are mutually reinforcing. Indeed, the dollar has an “exorbitant privilege” that no other currency has, in the words of former French President Valéry Giscard d’Estaing. The benefits of this privilege accrue to the US government and US businesses.
Still, many economists and financiers are speculating on whether and when the dollar might lose its status as the world’s preeminent reserve currency – and when its extraordinary rise, which began more than a decade ago and reached record levels this year year, could end. Foreign governments could lose their appetite for US debt. Republicans could force an avoidable showdown over the debt ceiling in the coming months. Europe could become a much more stable place politically than the United States, with freer and fairer elections. Any of these developments could cause other currencies to appreciate against the dollar.
One thing that won’t be? A global recession, which would likely drive more and more investors to look for safe assets, even if the United States is also heading into a recession.