The British economy is flailing and the pound is cratering. The American economy is flailing and the dollar is strengthening.
Indeed, the dollar is as strong as it has been in a generation. This year, it has appreciated roughly 16 percent against the euro, 21 percent against the pound, and 30 percent against the yen. It has also gained significantly against the currencies of a number of low-income countries. This is not because the United States is doing well per se, but because it occupies a strange sweetheart position in the global economy—one that stands to become sweeter as the world yet again teeters on the brink of recession.
A few factors have led to the U.S. seeing an unprecedented surge in the dollar, making imports cheap for American consumers. For one, the U.S. economy has its problems. The Fed’s aggressive efforts to tamp down on inflation may end up inducing a recession. The building pipeline is freezing up, a number of local housing markets are seeing significant corrections, and consumers are starting to pull back. Yet the U.S., which has a low unemployment rate, remains strong in comparison with its peers.
Europe, in contrast, has higher rates of inflation, as the continent struggles with a brutal energy crisis and the far-reaching fallout from Russia’s invasion of Ukraine. And many countries within it are facing their own particular struggles: Britain, for instance, has suffered amid a shambolic government, unstable financial markets, horrible fiscal plans, and a raging cost-of-living catastrophe, problems made only worse by Brexit—no wonder investors are ditching pound-denominated investments.
Developing countries are not faring much better. China’s zero-COVID policy has saved lives but hobbled its economy, which the World Bank expects to grow less than 3 percent in 2022, a rate half or one-third of normal. The Chinese housing sector is also collapsing. Many other countries are struggling with high commodity prices and fuel shortages. The strong dollar makes prices still higher, because countries in some cases have to import food and other goods denominated in dollars.
Investors around the world see the global economy stumbling. So they are fleeing to safety—meaning to investments in the United States, jacking the value of the dollar up even more. “The impact of the Russia-Ukraine war is weighing heavily on Europe’s outlook, while China’s COVID-19-related shutdowns and property market weakness are holding back growth in Asia,” argues Kathy Jones, the chief fixed-income strategist at the Schwab Center for Financial Research at Charles Schwab. “Even with the recent weak GDP growth, the U.S. still looks better positioned to weather a global economic slowdown.”
At the same time that the Fed’s interest-rate hikes have slowed the American economy, they have also made Treasurys more lucrative for investors in the short term. Various other factors are dampening interest in American government debt—something with profound implications for Washington’s finances and the future workings of the global financial system. But for now, Washington is offering higher interest rates than Brussels or London or Seoul.
These factors are only increasing the strength the dollar has long had because of its unusual role in international finance. Many commodities are priced in dollars. Many foreign central banks choose to hold dollars as reserves. Many international business contracts are executed in dollars. This creates a lot of demand for dollars, all the time. And as the senior International Monetary Fund official Gita Gopinath and the 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 that privilege redound to the American government and American businesses.
For all that, many economists and financiers speculate about whether and when the dollar might lose its status as the world’s preeminent reserve currency—and when its extraordinary run-up in strength, one that started more than a decade ago and has achieved record highs this year, might end. Foreign governments may lose their appetite for U.S. debt. Republicans may force an avoidable confrontation over the debt ceiling in the coming months. Europe might become a much more politically stable place than the United States, one with freer and fairer elections. Any one of these developments could cause other currencies to appreciate against the dollar.
One thing that won’t? A global recession, which would likely push more and more investors to seek safe assets—even if the United States heads into a recession too.