If this is a bad year for the dollar, I’ll take it. Widespread predictions of a sharp recession following a bumper harvest in 2022 have not materialized. USD is still a place to go. Not just in good times, but also when the rest of the world looks less inviting. More than just currency, it sometimes resembles a medieval fortress with a moat.
Last year’s epic rally was always going to be hard to recreate. So it’s not too bad that the dollar is trading roughly the same as it was on Dec. 31, according to the Bloomberg Dollar Spot Index . This is the result of a combination of forces: the Fed is laughing off rate cuts, China’s rally has failed and Japan can’t decide whether to ease its ultra-loose monetary policy. The eurozone is in trouble.
When in doubt, pile into dollars, especially with the Fed showing little sign of relief in its fight against inflation. Never mind that assertions of America’s long-term decline at the hands of China have been popular for years, and the idea has drawn some refreshing scrutiny. Are there deeper forces at work? A paper published by the New York Fed in December attributed the dollar’s primacy in large part to the so-called “sphere of empires.”
The basic idea is that the U.S. dollar is not only integral to world commerce, but is becoming increasingly important. When the Fed raises interest rates, the dollar appreciates, mostly at the expense of emerging markets. But when austerity policies cause the economy to slow, the effects are felt more outside the U.S. than at home. This is because exports and imports represent a relatively small portion of the U.S. economy. The demand for safe and liquid assets, primarily U.S. Treasuries, also plays a huge role.
This concept contains both irony and considerable tension. While the U.S.’s share of global GDP has declined relative to countries such as China and India, the dollar’s dominance has become more prominent. This asymmetry is a key element of the paper, and one of the paper’s authors, Dr. Gianluca Benigno, now a professor at the University of Lausanne, told me: “Because of the rise of Asia, the weight of the U.S. economy has changed over time. is declining. But at the same time, the rise of Asia combined with the more general role of the dollar…many countries are shorting safe assets.
“This one is very important. Until that is broken, it will be difficult to replace the dollar even if you start denominating it in other things. Safety and liquidity are needs of Asian pension funds because these countries do not have the ability to absorb their savings. This creates a demand for dollars The natural driving force of hegemony. It is the basis of hegemony.”
