America’s Strange Sweetheart Position in the World Economy

The British economy is struggling and the pound is cratering. The American economy is weakening and the dollar is strengthening.

In fact, the dollar is stronger than it has been in a generation. This year it has appreciated about 16 percent against the euro, 21 percent against the pound and 30 percent against the yen. It has also appreciated significantly against the currencies of a number of low-income countries. That’s not because the United States is doing well per se, but because it occupies an odd position as a darling in the global economy — a position that will get even sweeter as the world once again teeters on the brink of recession.

A number of factors have caused the US to experience an unprecedented rise in the dollar, making imports cheap for American consumers. For one thing, the US economy has its problems. The Fed’s aggressive efforts to contain inflation could eventually lead to a recession. The construction pipeline is freezing, a number of local housing markets are undergoing significant corrections and consumers are beginning to withdraw. Still, the US, which has a low unemployment rate, remains strong relative to its peers.

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In contrast, Europe has higher inflation rates as the continent grapples with a brutal energy crisis and the far-reaching fallout from the Russian invasion of Ukraine. And many countries within it face their own particular struggles: the UK, for example, has suffered from chaotic government, unstable financial markets, dire budget plans and a raging cost-of-living catastrophe, problems made only worse by Brexit – no wonder investors are on Drop pound denominated investments.

Developing countries are not faring much better. China’s zero-COVID policy has saved lives but is hampering its economy, which the World Bank expects to grow at less than 3 percent in 2022, a rate that is half or a third of normal. The Chinese housing sector is also collapsing. Many other countries are struggling with high raw material prices and fuel shortages. The strong dollar continues to push up prices as some countries have to import food and other dollar-denominated goods.

Investors around the world are seeing the global economy stumble. So they flee to safety – that is, to investments in the United States, which will boost the value of the dollar even more. “The fallout from the Russia-Ukraine war is weighing heavily on Europe’s prospects, while China’s COVID-19-related shutdowns and weakness in the real estate market are holding back growth in Asia,” argues Kathy Jones, chief fixed income strategist at the Schwab Center for Financial Research at Charles Schwab. “Even with recent weak GDP growth, the US still appears better positioned to weather a global economic slowdown.”

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While the Fed’s rate hikes slowed the US economy, they also made Treasuries more lucrative for investors in the short term. Various other factors are dampening interest in US government debt – something with profound implications for Washington’s finances and the future functioning of the global financial system. But right now, Washington offers higher interest rates than Brussels or London or Seoul.

These factors only add to the strength the dollar has long had given its unusual role in international finance. Many goods are valued in dollars. Many foreign central banks choose to hold dollars as reserves. Many international business contracts are executed in dollars. This constantly creates a large demand for dollars. And as senior International Monetary Fund staffer Gita Gopinath and 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, as former French President Valéry Giscard d’Estaing put it. The benefits of this privilege accrue to the American government and American businesses.

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Despite this, many economists and financial experts are speculating about if and when the dollar could lose its status as the world’s main reserve currency – and when its extraordinary rally, which began more than a decade ago and has reached record highs this year, could end. Foreign governments could lose their appetite for US debt. Republicans could force an avoidable confrontation over the debt ceiling in the coming months. Europe could become much more politically stable than the United States, with freer and fairer elections. Any of these developments could cause other currencies to appreciate against the dollar.

One thing not? A global recession that would likely have more and more investors looking for safe haven assets — even if the United States also enters a recession.

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