The US dollar has once again demonstrated its resilience and role as the world's refuge currency, even when the US itself is the source of global financial instability, as seen during the 2007-2009 financial crisis and currently. A series of global shocks since 2020, including the pandemic, significant fiscal and monetary expansion, supply chain disruptions, and Russia's invasion of Ukraine, have fueled inflation in the US and prompted the Federal Reserve to tighten monetary policy more aggressively than other high-income countries' central banks. This proactive stance by the Fed has led to a significant appreciation of the dollar.
Between the end of last year and a recent Monday, the nominal effective exchange rate of the US dollar appreciated by 12%, according to JPMorgan estimates. In contrast, the yen's effective rate depreciated by 12%, the pound's by 9%, and the euro's by 3% over the same period. When measured solely against the dollar, these movements are even larger: sterling has depreciated by 21%, the yen by 20%, and the euro by 16%. This underscores the dollar's dominant position in the global currency market.
The strength of the dollar has contractionary pressures on the world economy due to the disproportionate size and influence of US capital markets and the dollar as a global safe haven. Changes in financial flows to or from the US impact economies worldwide, especially those with heavy dollar-denominated liabilities. While some countries, like Japan, might tolerate a weak currency, most are concerned about exchange rates due to inflation. There's discussion of coordinated currency intervention, similar to the Plaza and Louvre accords of the 1980s, but the Fed's current focus on inflation makes such intervention unlikely unless it aligns with US domestic goals.
A more critical question is whether central banks, in their simultaneous tightening, are going too far. The eurozone, for example, faces weak domestic inflationary pressure and a probable recession next year. Despite this, central banks, including the ECB, are committed to curbing inflation, even if it risks overkill. The current environment also highlights the importance of fiscal sobriety for governments, as the ability of central banks to support markets is diminished, and the financial tide is revealing underlying vulnerabilities for indebted nations.
The dollar system's vulnerabilities to presidential whims and its historical evolution were also discussed by figures like Mark Carney and Stanley Fischer. Carney argued for a "synthetic hegemonic currency," while Fischer pointed to the US President as the source of issues, not the International Monetary and Financial System itself. Despite these discussions, the dollar's enduring role is partly due to central bank coordination, with mechanisms like eurodollars and central bank swaps demonstrating a long-standing, quiet acceptance of the dollar as the de facto global currency.
