The US dollar is strengthening and posing a threat to the global economy

It is well known that the dollar plays a role in global finance and trade out of proportion to the US share of the world economy.

The US nominally contributes about 24 percent to global GDP, or about 15 percent in purchasing power parity terms. However, it is used in about half of all commercial accounts, accounts for more than 60 percent of official foreign exchange reserves, and about 60 percent of international liabilities and foreign currency liabilities are denominated in dollars. A third of the world’s countries peg their own currency to it, and two-thirds of emerging market debt is denominated in dollars.

The NY Fed team argues that this outsized role in global finance is the first of two major asymmetries within the international monetary system.

Second, the US economy is less exposed to movements in world trade than its trading partners.

While China, the eurozone and some developing countries have increased their exports significantly relative to the size of their economies, the contribution of exports to the US economy has been smaller and stagnant.

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The researchers say the dichotomy represented by the asymmetries — the dollar’s role in international trade and finance, and the US economy’s dependence on the world economy — sets the conditions for the dollar to act as a “self-fulfilling procyclical force.” .”

Of course, this could work both ways. However, when Fed monetary policy becomes “hawkish” – as it is currently doing – the more pernicious “imperial circle” of a contraction in global output begins due to the extent of dollar billing within the credit-intensive world value chain.

The decline in global manufacturing, they say, eventually spills back into US manufacturing due to manufacturing linkages and a drop in foreign demand for US products. It also leads to falling commodity prices and a drop in world trade.

Emerging markets are hardest hit, as the increase in competitiveness from currency depreciation is more than offset by higher dollar-denominated commodity and debt costs and the impact of capital outflows as their currency weakens. The outflows reduce investment and have a destabilizing impact on the domestic economy and its financial systems.

The US — because it is less dependent on world trade — benefits relatively (though not necessarily absolutely) from a global economic downturn that strengthens the imperial circle, the researchers say.

The dollar’s role within the global economy and financial system continues to draw criticism and attempts to mitigate its impact.

His “armament of arms” to enforce sanctions against Russia, Iran, North Korea and, to a limited extent, China has generated controversy and spurred the development of alternatives.

China and Russia trade directly in their own currencies, and China has attempted to increase the proportion of its trading activities denominated in yuan, including recent efforts to persuade Middle Eastern oil producers (with limited success) to accept its currency .

However, the dollar’s tenure as the world’s reserve currency and the network advantages that come with it make it almost impossible to challenge the dollar’s position except over the very long term.

While China is the obvious (and emerging) challenger, its aspirations are hampered by the presence of capital controls and the lack of a deep and liquid bond market. A lack of trust and transparency in the judicial system – a requirement for a reserve currency – is another major obstacle.

If the Fed tightens further and faster than the other major central banks, the US dollar will appreciate, as it has since early last month.

China has blamed the US for flooding the global system with dollars during the pandemic, sending global inflation skyrocketing and triggering currency depreciation and capital outflows that have hurt other economies, particularly emerging markets.

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It’s hard to disagree with this view, but there is always something negative and potential about the dollar’s dominance in the post-WWII era, which was fundamental to the globalization of trade and finance and helped China and other developing countries to prosper brought with it destabilizing effects on the rest of the world.

If the Fed does what Powell said it was willing to do in the absence of evidence of a slowdown in US inflation, the dollar’s pro-cyclical role in the global economy – likely contractionary influence in this case – will carry over some of these negative and destabilizing effects.

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