© Reuters. FILE PHOTO: An illustration showing a US $100 banknote is taken in Tokyo on August 2, 2011. REUTERS/Yuriko Nakao
by Mike Dolan
LONDON (Reuters) – Even if the US dollar’s unique dominance as the world’s currency of choice is in fact ebbing, it may not automatically lead to a weaker dollar’s exchange rate — and it may periodically mean the opposite.
The Fed is less concerned about excessive monetary policies for the rest of the world, and it is a central bank that is more inclined to tighten and to be very easy. And a global economy less reliant on the dollar could free up the Federal Reserve to remain domestically focused—for better or for worse—and keep inflation low over time.
Throughout the 50-year floating exchange rate era, debate has raged over the “exorbitant privilege” the United States takes on the dollar as the world’s reserve currency, and numbers have raged since French leaders first used the phrase.
The great advantage of large holdings of dollar reserves along with the wide commercial use and trade of dollars abroad was evident. U.S. companies avoided additional currency fluctuations in dollar-billed imports such as energy and commodities while Washington actually enjoyed subsidized borrowing as other countries reserves or saves windfall dollars in Treasury bills.
The strategic power of being able to limit the use of the world’s most widely circulated currency for political reasons—more evident than ever in recent years—was another.
But many have also argued over the years that the dollar’s international role has often hindered the Federal Reserve from pursuing the policy most favorable to the domestic economy — mainly because of fear that extreme moves could shock a global financial system complete with the opposite economic impact hitting the US economy on any side. case.
For now, a similar argument can be made with Fed policymakers pushing harder than ever to tighten as a way to get inflation back on target just as other regions of the world, such as China, are struggling economically, wary of falling prices and looking for relief.
Was this divergence widening and causing dollar downward pressure, could the Fed tread more carefully? Or if cost dollars matter less to the rest of the world than they have in decades, will you continue to work regardless?
The so-called “de-dollarization” has been the subject of endless speculation since the post-pandemic geopolitical realignments and the freezing of Russia’s foreign reserves after it invaded Ukraine last year.
Although reductions in dollar holdings and uses have been relatively small despite the perceived high risk of sanctions, the BRICS grouping made up of Brazil, Russia, India, China and South Africa — and already heavily sanctioned economies like Iran and Venezuela — certainly urged a dollar carve-up. Out of trade and investment since then.
But the problem is usually read in markets as a reason to bet on dollar weakness – or even to pump in alternatives like gold or cryptocurrencies.
It may not necessarily work that way — especially if it leads to Fed tightening, higher bond yields, and lower inflation over time.
‘oasis’
One of the clearest examples of the Fed’s indecision was when Alan Greenspan’s team cut interest rates three times in 1998 despite the rapidly growing US economy and advanced technological boom, arguing that the US could not remain an “oasis of prosperity” in the storm of global emerging markets. and a credit shock that was arguably exacerbated by the Fed’s sharp tightening in 1994.
By late 1999, the Fed quickly reversed all those cuts, then had to narrow three more times to a peak of 6.5%—eventually poking what became a runaway dot-com bubble.
Of course, this was a global economy riven by pegs of fixed exchange rates to the dollar that shipped the Fed’s policy move, most of which has since been dismantled.
The Fed now has many other tools – such as multilateral dollar swap lines – to ease tensions.
But it wasn’t the only time the Fed’s policy was cut short or affected by dollar pressure abroad.
Before taking up her current position as Treasury Secretary, Janet Yellen recalled her time as Federal Reserve Chair and claimed that when the prospect of Fed tightening in 2015 triggered massive capital inflows from China and turbulent world markets, it forced the Fed to stop raising rates. interest temporarily. campaign.
The opposite was also true.
When the Fed first embarked on quantitative easing after the Great Financial Crash of 2008, there were outcries from emerging powers like Brazil that the US was fighting “currency wars” to weaken the dollar for trade gain.
Yellen also spoke about G-20 meetings as Fed chairwoman in which criticism arrived over whether the Fed was loosening or tightening, with complaints mostly about extremes in policy moves, and the Fed was “sensitive to these concerns.”
Fed studies — including one from the Fed’s economists on “fallouts” late last year — show a much greater exchange rate impact from Fed tightening in their ‘dollar dominance’ model than in the benchmark situation without it – Which indicates much less overseas influence in the latter. And a larger range for higher rates.
They said: “Central banks around the world are taking into account and absorbing these repercussions.” “But policymakers have a difficult balance to manage.”
At the very least, a world that is less sensitive to the dollar because it uses it less for trade and reserves may also be a world with structurally higher interest rates in the US – and perhaps a more volatile world to boot.
This would be a world many countries would prefer if they were certain of viable alternatives – but that may not mean a weaker dollar.
The opinions expressed here are those of the author, a Reuters columnist
(Written by Mike Dolan, Twitter: @reutersMikeD.; Editing by Kirsten Donovan)