Guest Contribution: “The Dollar Dazzles Once More”

Today, we present a guest post written by Jeffrey Frankel, Harpel Professor at Harvard’s Kennedy  School of Government, and formerly a member of the White House Council of Economic Advisers. An earlier version appeared at Project Syndicate.

September 24, 2022 — The dollar is sky-high.  Since May 2021, it has risen 19 % against Europe’s euro, even reaching 1-to-1 parity in recent weeks. The dollar is up 20 % against Britain’s pound.  And it is up 28 % against Japan’s yen, provoking the Bank of Japan to sell dollars on September 22, essentially the first foreign exchange intervention by a G-7 country since 2011 and the first in the direction of supporting its currency’s value against the dollar since the euro in 2000.

On the basis of a weighted-average among major trading partners, the dollar is the highest it has been in twenty years.  In fact, when judged against a broad set of foreign currencies, the US currency is now even stronger than it was in 2002.  One has to go back to 1983-85 to find an episode when the dollar was clearly higher than it is today.

It may seem surprising that the dollar is so strong currently, during a period of high US inflation and slowing growth, both of which have received a huge amount of attention and both of which, in themselves, should have negative effects on the demand for dollars.  So, does the current exchange rate belong on the ever-lengthening list of recent developments that seem inexplicable or unprecedented?  No.  The dollar’s strength can be explained by economic fundamentals.

  1. The effect of growth rates

It is true that the US economy has slowed markedly this year, relative to the rapid 5 ½ % growth rate during 2021, and that many are calling this a recession.  But it is the differential in growth rates that matters for determination of the exchange rate.  And other countries are more likely entering recessions now than is the US.

The US economy remains relatively strong, so far, when judged by the labor market and other important indicators.  Meanwhile, the United Kingdom and continental Europe are in the throes of an energy crisis, due to the loss of Russian natural gas.  Growth in China has almost vanished, suffering from the effects of a bursting housing bubble and continued futile pursuit of a zero-Covid policy. Japan’s anemic growth rate has yet to restore its GDP to where it was in the years preceding the 2020 recession.

  1. The effect of high commodity prices

The US inflation of 2021 turned out not to be transitory.  And inflation makes people very unhappy.  But it has risen almost everywhere.

One circumstance in which inflation has a negative effect on a country’s real income and the real value of its currency is when the prices of the goods that the country imports and consumes rise relative to the prices of the goods that it produces and exports.  Such an adverse shift in the “terms of trade,” reminiscent of the supply shocks of the 1970s, describes the current situation among countries in Europe and East Asia that are dependent on imports of fossil fuels, minerals, and agricultural commodities. But the US has always been a net exporter of minerals and farm products, and in recent years has again become a net exporter of energy (thanks in part to fracking).  So, the US has not suffered the same adverse shift in the terms of trade that others have.  Greater sensitivity to the recent commodity shocks among trading partners is one factor explaining the depreciation of their currencies against the dollar.

  1. The effect of rising interest rates

Unlike countries suffering from an adverse shift in their terms of trade, the US can offset the costs of inflation by tightening monetary policy — which is precisely what the Fed has been doing all year.  That includes another 75-basis point increase in the short-term interest rate by the Federal Open Market Committee on September 21.

The differential in monetary policies between the US and other major countries is probably the main force acting on the dollar The Fed is raising interest rates faster than the European Central Bank is.  Meanwhile the Bank of Japan has yet to move away from its super-easy monetary policy and even continues to hold down longer-term rates.  The widening of the interest rate differential makes dollar assets more attractive to global investors and hence works to appreciate the currency.

Furthermore, the dollar retains its status as a safe haven, a destination for nervous capital whenever global risk spikes.  It remains the leading international currency.  The euro, yen, pound and yuan trail well behind, by such measures as the currency composition of foreign exchange reserves or the volume of foreign exchange trading.

  1. Effects of dollar appreciation

So much for the causes of a high dollar.  What are the effects?

It comes with pros and cons.  From the viewpoint of the US, the pro is downward pressure on inflation, while the con is a loss of competitiveness in international trade.  From the viewpoint of other advanced countries, the pro is a gain in international competitiveness and the con is an exacerbation of inflation, particularly in the form of the higher commodity prices they face.

Meanwhile many developing countries (even the commodity exporters, which benefit from higher global commodity prices), have to contend with the problem of currency mis-match: if they have dollar-denominated debts, the increase in the cost of dollars in terms of their own currencies raises debt service requirements in terms of their own currencies.

The US is likely to face rising complaints about dollar appreciation, a sign of  “reverse currency wars,” and to hear calls for cooperation among central banks to limit the increase in interest rates.  There may even be proposals for a new Plaza Accord, an effort to intervene in the foreign exchange market to bring the dollar back down to earth, as happened in 1985.  But the current episode of dollar appreciation is rooted in economic fundamentals: economic strength in the US relative to trading partners and (consequently) interest rates that are rising in the US faster than abroad.  So long as that remains true, a strong dollar makes sense.

 This post written by Jeffrey Frankel.

22 thoughts on “Guest Contribution: “The Dollar Dazzles Once More”

  1. Moses Herzog

    Good/dependable leadership = trust in a nation’s currency = increase in that same nation’s currency’s value

    Trump out/Biden in = more trust in the U.S. dollar = drastic increase in the U.S. dollar’s value

    Do I need to explain this to sh*t-head O’Rear again, or…….. ??

      1. pgl

        Hey Bruce – do you know Jeremy Siegel? Didn’t think so. Jeremy is a good finance economist but he is not a macroeconomist. Buy yea – he knows a lot more than Elon Musk. But why don’t we ask someone who is on the FED:

        Atlanta Federal Reserve President Raphael Bostic said on Sunday he still believes the U.S. central bank can tame inflation without substantial job losses given the economy’s continued momentum.

        Oh I’m sorry – I ruined your little RECESSION CHEERLEADING party. Excuse me. Now go back to hoping the US economy tanks and all the citizens of Ukraine die. You are that kind of guy!

        BTW Bostic does happen to be black so I know your KKK buddies will dismiss his insights.

        1. Anonymous

          currency comparisons in horse in terms: usa currency is soundest old nag in the line at the glue factory

          if any here remember horse drawn carts in us cities….

      2. T. Shaw

        “Good/Dependable Leadership.” = No mean tweets; half-off sale on Americans’ 401k and IRA plans; runaway inflation, crashing asset classes; hundreds of thousands of fentanyl deaths; national destabilization of 5,000,000 illegals; murder rates through the roof; etc. But Orange Man Bad ist kaput.

        ‘Dollar Dazzles’ translated, “In the kingdom of the blind the one-eyed man is king.”

        US asset classes crashing from January 2021 when Dear Leader Biden took over: DJIA (5%); NASDAQ (21%); Gold (12%); 10 year US Treasury market rate up 243% from 1.10% to 3.67% with concomitant decrease in market values; inflation up 315% from 2% to 8.3%; etc.

        The YTD equities numbers are worse: DJIA (19%); NAS (31%).

        “I see.” said the blind man as he picked up his tools and walked away.

  2. ltr

    Terrific essay, but:

    “The US is likely to face rising complaints about dollar appreciation, a sign of “reverse currency wars,” and to hear calls for cooperation among central banks to limit the increase in interest rates. There may even be proposals for a new Plaza Accord, an effort to intervene in the foreign exchange market to bring the dollar back down to earth, as happened in 1985. ”

    The Plaza Accord or severe increase in value of the Yen, proved industrially and financially harmful to Japan, to an extent the Japan has grown poorly ever since. I cannot imagine Asian countries in particular allowing such an artificial decrease in dollar value.

    1. Macroduck

      The Plaza Accord accounts for the pattern of Japanese economic growth since 1985? Seriously?

      The “endaka” recession was pretty obviuosly the result of yen appreciation, but growth in the five years after the endaka looks a lot like the five years’ prior:

      Japan’s real estate bust is generally understood to be the beginning of slower growth and weak inflation. If the BOJ hadn’t balked at hiking rates due to concern about Black Monday in the U.S., at least some of the asset crash could have been avoided.

      Plaza? Seriously?

    2. pgl

      I had to think about this for a while as I am more used to thinking about what Dr. Frankel wrote here:

      The term “currency wars” was originally a colorful description of what international economists had long called “competitive devaluations” or, after exchange rates began to float in the early 1970s, “competitive depreciations.” In these situations, countries feel aggrieved that their trading partners are deliberately pursuing policies to weaken their own currencies in order to gain an unfair advantage in international trade. Competitive depreciation can arise when all countries’ main macroeconomic goals, in addition to maximizing GDP growth and employment, include improving their trade balances. This generally describes the past few decades in the world economy.

      Yea I’m a die hard inflation dove so the idea that everyone is trying to raise to the top to curb inflation with little concern about the possibility of a global recession bothers me. But it does seem central banks globally are doing just that. Maybe Lawrence Summers thinks this is a necessary thing to do but I do not.

      1. Barkley Rosser


        Oh, this is much older. See Joan Robinson’s 1937 article on “Beggar-Thy-Neighbor Policies,” which was all about competitive devaluations in the Great Depression.

        1. pgl

          A classic which captured the expenditure-switching aspects of competitive devaluations but as Bernanke noted easy money also has expenditure adjusting effects.

    3. Jeffrey A Frankel

      This story, that the 1985 Plaza Accord led to endaka (strong yen) which in turn ushered in many years of Japanese stagnation (which started in 19900, is commonly told in Asia. But it always has seemed to me that it neglects the intervening years, 1987-89, when easy BoJ monetary policy led to a bubble in Japanese land and stock market prices and put upward pressure on the yen/$ rate.
      — JF

      1. Macroduck

        Taking your various comments together, you seem to imply that FX rates explain Japan’s slower growth, relative to South Korea and China. That view ignores the real message of the growth in per capita income.

        I should also note, there is a good bit of misdirection in your choice to index GDP per capita to 1980, instead of using actual values. Here’s a less deceptive treatment of GDP per capita for the three countries you’ve chosen:

        Japan arrived at the pinnacle of economic development in the 1980s. Once convergence was achieved, growth slowed. South Korea is catching up quickly. China has some way to go. The country which is furthest from achieving convergence grows fastest, all else equal. China simply took longer to realize what it was doing wrong.

        There is an old idea that finance is the handmaiden of the economy. When currency agreements and financialshocks and the like become the focus of attention, there are two lesons we might draw. One is that we should tend more to the real economy. The other is that the financial economy has become too influential and ought to be reined in.

  3. Macroduck

    Speaking of things financial (so not really off topic?), the Global Wealth Report (not to be confused with the World Wealth Report) –

    The Credit Suisse Global Wealth Report for 2021 is out. Here’s the teaser:

    “The thirteenth edition of the Global Wealth Report shows continued wealth growth across all regions led by North America and China. Total global wealth grew by 9.8% and wealth per adult reached USD 87,489. Setting aside exchange rate movements, aggregate global wealth grew by 12.7% in 2021, which is the fastest annual rate ever recorded.”

    Of course, the collapse in wealth in H1 of 2022 was the fastest “ever recorded” in the thirteen year period covered by Global Wealth Reports. That collapse continues so far in H2.

    The CS Report series is to new to cover the last great wealth boom – and bust – in the mid-and-late 2000s. The Capgemini/Merrill Lynch World Wealth Report is older, wnd in 2009 reported:

    “While World Wealth and High Net Worth Population shrink below 2005 levels, overall HNWI wealth expected to grow at annual rate of 8.1% by 2013.

    “Worldwide, HNWI wealth drops 19.5%…”

    There is a reliable pattern of asset price inflation followed by rapid deflation. The Fed has a financial stability mandate along with its price stability mandate. I don’t recall a Fed chair ever threatening recession in order to cool asset price inflation.

    Over at “Naked Capitalism”, the highlighted factoid from the CS report is that median wealth in China now surpasses that in Europe – we have to allow Yves and Lambert their “we suck” schadenfreude regarding the West. Credit Suisse puts the slower pace of European wealth accumulation in 2021 down to currency effects and notes that much of Western Europe still has median wealth several times that of the median in China. It’s worth noting that the social safety net in China is less extensive than in Europe:

    Including the net present value of future social support payments would likely change the relative picture considerably.

    1. AndrewG

      All good points, and about Chinese wealth, well, that’s the opposite of the stated Chinese goal of rebalancing towards more consumption and less savings. It’s more of a failure than a success. (Might be racist to mention that though.)

  4. benamery21

    Japan and the yen would be doing much better in the current economic circumstances if they simply turned back on their idle nukes and sold their contracted LNG supply and LNG shipping capacity on to Europe, et al. This would also help Europe a bit.

    1. baffling

      you do understand the japanese reluctance to turn their nukes back on, don’t you? they have already had one nuclear meltdown on their land.

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