Strong Dollar: The "Disruptor" of the Global Economy

Due to the expectation that the US economic data would be strong or that the Federal Reserve would postpone the interest rate cut, the US dollar index soared. On July 28th, it achieved its largest single-day increase since May, reaching 98.634. The US dollar has risen strongly in the international currency market, like a huge stone dropped into a calm lake, causing waves and ripples, and drawing widespread attention from the global financial community. The strengthening of the US dollar has an impact on global financial markets and international trade settlements, and will also affect the exchange rate trends of other currencies and the flow of funds.

From historical data, it is not uncommon for the US dollar to experience cyclical fluctuations. Since the disintegration of the Bretton Woods system, the US dollar has undergone multiple cycles of appreciation and depreciation. However, the current strong rise of the US dollar has some unusual features. On one hand, the share of the US dollar in global reserve currencies has continued to decline, from 66% in 2015 to 58% today, but the US dollar index has performed strongly. The deviation between the status of reserve currency and the strength of the exchange rate, which breaks the traditional perception of a positive correlation between the two, is noteworthy. On the other hand, the US trade and fiscal deficits have continued to deteriorate, and during the COVID-19 pandemic, there was a large-scale "money printing". In 2020 and 2021, the US fiscal deficit accounted for more than 10% of GDP. According to common sense, this would lead to a weakening of the US dollar, but this round of the US dollar cycle was not affected by the "double deficits", and remained strong. Moreover, from 2021 to 2022, US inflation significantly rose, with the year-on-year growth rate of CPI once exceeding 9%, but the US dollar did not depreciate; instead, it continued to strengthen, contrary to the trend of US inflation.

So, what factors have driven the current strong rise of the US dollar? From a fundamental perspective, the relative performance of the US economy in the global context has played a crucial role. During events such as the European sovereign debt crisis in 2009 and the slowdown of the Chinese economy in 2015, the relative advantages of the US economy gradually became more prominent. After the pandemic, due to the impact of the Russia-Ukraine conflict and structural factors such as population aging, European economic growth lagged significantly behind that of the US. The US economy's dominance globally further strengthened the advantage of the US dollar.

From a policy perspective, the monetary policy of the Federal Reserve is a significant driving force. Tightening monetary policy often boosts the strength of the US dollar. In 2022, Powell's aggressive tightening policy significantly strengthened the US dollar. After the financial crisis, the interest rate gap between the United States and other economies continued to widen, providing support for the appreciation of the US dollar.

The issue of capital flows cannot be ignored either. The new generation of open macroeconomic literature emphasizes the impact of cross-border capital flows on exchange rates. Empirical studies have found that the flow of funds in financial accounts has a more significant marginal effect on exchange rates. Geopolitical factors also play a role. The 2022 conflict between Russia and Ukraine hit Europe, causing a large amount of capital to flow out of Europe and into the United States, which pushed the US dollar to strengthen.

The strong rise of the US dollar has had various impacts on the global economy. In the international trade landscape, countries that rely on exports, see the prices of their goods rise relatively in the international market, resulting in a decline in competitiveness and a decrease in exports. On the contrary, for importing countries, the cost of imports decreases, which may lead to an expansion of import volumes. In terms of exchange rates, a stronger US dollar causes other currencies to depreciate relatively. Some emerging economies may face pressure from capital outflows. Investors tend to invest their funds in US dollar assets to obtain higher returns and stability, which may trigger financial market turmoil in these countries, with stock markets and bond markets falling. The global debt market is also affected. A stronger US dollar increases the debt burden denominated in US dollars, and some developing countries may face debt repayment difficulties, increasing the risk of debt default. The commodity market is also not spared. A stronger US dollar usually leads to a decline in the prices of commodities such as oil and gold, as commodities are typically priced in US dollars. The appreciation of the US dollar reduces the cost of purchasing these commodities.

For the global economy, the strong rise of the US dollar is a double-edged sword. On the one hand, it brings certain economic benefits to the United States, such as making imported goods cheaper, which helps alleviate domestic inflationary pressure; American enterprises also enjoy certain advantages when investing and raising funds overseas. On the other hand, it brings many challenges to other countries in the world. Emerging economies are facing problems such as capital outflows, currency depreciation, and increased debt burdens, which may trigger financial market turmoil and economic recession. Other developed countries are also affected to varying degrees, such as the Eurozone, which is bearing the inflationary pressure transferred from the United States due to the depreciation of the euro against the US dollar.

In the face of the challenges brought about by the strong rise of the US dollar, countries need to take corresponding measures. Export-oriented countries can increase the added value and competitiveness of their products by means of currency devaluation, strengthening industrial upgrading and technological innovation, while also strengthening macroeconomic policy regulation to maintain stable economic growth. Emerging economies should strengthen financial supervision to prevent capital outflows risks, stabilize exchange rates and financial markets. In terms of international cooperation, countries can enhance currency swap arrangements, trade cooperation, etc., to jointly address the challenges brought about by the strengthening of the US dollar.

Looking ahead, the future trend of the US dollar remains highly uncertain. Factors such as the future performance of the US economy, the direction of the Federal Reserve's monetary policy, and the geopolitical situation will all have an impact on the trend of the US dollar. However, in any case, the strong rise of the US dollar has sounded the alarm for the global economy. The diversified development of the international monetary system is imperative, as only in this way can the reliance on a single currency be reduced and the stability and risk-resistance capacity of the global financial system be enhanced.