The global economy may be changing more slowly than you might think. How the dollar continues to serve as the global currency standard and what it tells is about the economy and the world.
WASHINGTON, D.C.—Stare hard enough at a dollar bill, which they actually print here, and you can get a pretty good sense of the state of the economic cycle, the structure of the global economy and even the future of the free world.
Assembled bankers and investors at the IMF and World Bank Annual meetings last week shared their worries about deteriorating economic data and unraveling political alignments, but there seemed very little likely to change either the current value or long-term role of the dollar.
Stronger for longer
Pure economic analysis would hardly suggest the dollar should have strengthened 14% over the last five years1. Mounting government debt, a widening deficit and a bitter budget all point to a currency that should not retain value. Add in a rising current account deficit, looser monetary policy and the uncertainties of a major election, and the case to short the dollar becomes stronger still.
But, of course, a currency’s value is measured against other currencies, and the picture is largely worse elsewhere. European growth may barely top 1.4% next year if the IMF’s forecasts are close. Japan may not grow at all. With $13 trillion in bonds priced to deliver negative yields, the euro and the yen don’t look very attractive either2.
“Perhaps most surprising is the continuing faith in the dollar amid all the concern that U.S. politics have turned more inward and self-interested.”
Meanwhile, as much as the president complains about the Fed’s role in keeping the dollar strong, his own tariffs have probably played a greater part as they deliver shocks to America’s trading partners. This has weakened their currencies directly and hands an excuse to countries with managed currencies to float a little lower.
What could lead it weaker? A U.S. recession, of course, perhaps triggered or aggravated by the strong dollar itself. A strong dollar keeps imports cheap and inflation low, but it hurts both U.S. exports and foreign revenue, which now account for 43% of the S&P 500 companies.
But, again, it’s a relative game, and the U.S. slowdown would have to be sharper and deeper than anything in Europe or Japan, which is hard to imagine today.
What your money can buy
Where investors complain about the dollar’s temporary strength, governments bemoan its dominance of the global financial system. Foreign markets are now highly dependent on dollar liquidity for stability and thus deeply affected by U.S. monetary policy.
U.S. financial sanctions rankle, fueling complaints about Washington’s arrogance and overreach. Iran and Russia have searched for ways around the global financial system dominated by the dollar, but with very limited success. Even as Europeans diverged from the Trump Administration on Iran sanctions, their effort to develop a quasi-barter channel has yet to deliver results.
The problem, quite simply, is that there are so many more goods, services and financial instruments you can buy with dollars than with anything else. That’s why 44% of all foreign exchange transactions involve dollars and 40% of all international bank transfers are in dollars.
What is perhaps truly striking is that while the U.S. accounts for 21% of global trade, a little over 40% of global trade is invoiced in dollars. Dollars are just more useful as a unit of account for businesses with suppliers and customers across many countries. Firms can better analyze their own profitability, and customers can better compare prices.
These are neither inevitable nor permanent patterns, but they won’t be disrupted without a viable alternative.
Perhaps most surprising is the continuing faith in the dollar amid all the concern that U.S. politics have turned more inward and self-interested. Some two-thirds of all reserves are still denominated in dollars. More striking, approximately 60% of U.S. dollar bills are now overseas. Even as Turkish and U.S. troops line up on opposite battle lines and the Turkish government pursues new ways to settle its trade with Russia in rubles, more than half of all Turkish bank deposits are in dollars.
THE U.S. DOLLAR AND THE TWIN DEFICITSSource: Bloomberg as of September 30, 2019
The faith in its institutions and the economy’s ability to grow remains. As a test, ask yourself: if you had to put all your money in one currency and not touch it for 25 years, which currency would you choose? You are among a rare few if you chose renminbi or bitcoin.
Overall, the dollar’s value, role and prestige suggest a world that may not be changing as quickly as the headlines might lead you to believe. Some may find that troubling, but for investors it may be reassuring in a world fraught with turmoil.
1. U.S. Dollar Index, Bloomberg as of October 18, 2019
2. Bloomberg Barclays Index as of October 18, 2019