Part of this story follows a familiar pattern: in times of trouble, currency traders and investors flock to the dollar as a safe haven. This was true even in the global financial crisis of 2008, when the US financial collapse was the focus. Right now, many factors are driving demand for the safety of US assets: the war in Ukraine, Europe’s energy crisis and uncertainty about how some emerging markets will handle high oil and food prices. The US is essentially the least insecure option, especially given its position as a net energy exporter. Economic fundamentals are also supporting the greenback. At this year’s Jackson Hole conference, Federal Reserve Chairman Jay Powell’s speech was brief but clear in its message: the Fed will not hesitate to push interest rates even further in an effort to reduce inflation, which is still running more than four times its target. This increases the relative appeal of dollar-denominated securities, with central bank policy rates lagging behind other advanced economies. The outlook for the eurozone and Chinese economies has also darkened, while recent data points to some resilience in the US, alongside President Joe Biden’s fiscal support. Some idiosyncratic factors also contributed to the weaknesses of some currencies. Russian President Vladimir Putin’s weaponization of natural gas flows means the European economy is in for a huge terms-of-trade shock. Uncertainty about how it will overcome the energy crisis has investors worried. In Britain, confidence in fiscal credibility has been hit by the new government’s already strained public finances, attacks on independent financial institutions and massive borrowing plans. Meanwhile, the Bank of Japan has insisted on a fairly loose monetary policy to stimulate growth and inflation. The strength of the dollar, in turn, has profound implications. In developed economies, central banks are playing catch-up with the Fed to prevent a further weakening of their currencies – which also increases imported inflation. Rising interest rates are even more problematic for some, as energy crisis borrowing adds to already high pandemic debt. In emerging countries it threatens balance of payments crises by increasing dollar-denominated debts and leading to disruptive capital outflows. About 20 emerging markets have debt trading at unfavorable levels, according to the IMF. There are no quick fixes. The only sustainable way for advanced economies to regain ground on the dollar is through credible and prudent policies that will steer them through the current crisis and onto higher growth paths. For the emerging world, better coordinated multilateral debt restructuring is key. America’s shrinking share of global output, the rise of digital currencies and the dollar’s weaponization of sanctions against Russia have been cited as reasons for its potential collapse. However, the currency still has a large influence on the global economy, given its dominant role in global trade and finance. In 1971, then US Treasury Secretary John Connally warned his international counterparts that the dollar was “our currency but your problem”. More than 50 years later, his words still ring true.
