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“The planets are aligning in favor of the US dollar, watch out for the return of the currency war"

Since the beginning of the year, the Dollar Index, which measures the variation of the American dollar against a basket of six major currencies including the euro and the pound sterling, has risen by 6.8%. The rise in the dollar is widespread: 8.2% against the euro and the Swiss franc, 9.7% against the pound sterling and 13.1% against the Japanese yen since January 2022, for example. It is certainly only the beginning. Institutional investors continue to be massively (buyers) on the dollar according to the weekly report published by the Commodity Futures Trading Commission based in the United States.

Since the 1980s, the dollar has gone through three cycles covering both periods of rise and fall: 1980 until the beginning of the 1990s (beginning of a cycle of rate hikes under Alan Greenspan), 1995 to 2011 ( end of the financial crisis in the United States), and since 2015 (rate hike under Janet Yellen). The peak of the last cycle, in progress, has not yet been reached, according to all logic. We must therefore expect a more pronounced increase in the Dollar Index in the future.

In the space of a few weeks, the number of risk factors has increased, which should benefit the dollar over time: war in Ukraine (although the impact is less now), commodity super-cycle, constant disruptions in the level of international trade, risk of technical recession in several developed economies (in the United Kingdom and, to a lesser extent, in France) and stagflation in others (in Germany, this is certainly already the case). In these circumstances, the demand for dollars will continue to increase at a time when, precisely, the American Federal Reserve will withdraw liquidity (via its balance sheet reduction which will start next month). This will also contribute, to some extent, to the rise of the greenback.

We are facing a market where the US dollar remains hegemonic, with ultimately quite a few possible alternatives for operators looking for safe havens. The Swiss franc is not the best option due to the regular interventions of the Swiss National Bank (nearly 4.2 billion francs have been committed over the past two weeks to support the exchange rate of the Swiss currency according to our calculations). The Japanese yen is not one either due to the maintenance of an ultra-accommodative monetary policy by the Bank of Japan (ultra-low rates and control of the yield curve) which reduces the attractiveness of the Japanese currency. .

A new round of dollar appreciation

The rise of the US dollar is not good news for almost anyone. Economics textbooks tell us that a strong dollar has two major consequences: US economic activity slows and US inflation is exported through trade. In reality, in a world where all players borrow and invoice in dollars, the rise in the greenback has above all four main impacts: it leads to a reduction in international trade, a drop in cross-border bank loans, a fall in (spending capital of companies) and a deterioration of international value chains which have been highly dependent on the dollar exchange rate since the 1990s.

A study by Emine Boz (2017) showed that a 1% appreciation of the US dollar reduces internationally traded volumes by an average of 0.6-0.8% over a year. Considering that the rise in the dollar will certainly be close to at least 4% this year, this leads to a drop in traded volumes of at least 2.4% in one year. It’s massive. This means less global growth and an even more unequal distribution of wealth (since the United States, due to the strength of the dollar, remains the big winners).

In this context, emerging countries are the most vulnerable. A study by the Bank of England has shown that a 10% rise in the US dollar results, on average, in a drop of 1.5 percentage points in the GDP of emerging countries. For the moment, no similar study has been carried out on developed countries. We can just assume that the impact is less, due to a lower dependence on financing in dollars.

Alternative solutions that lack credibility

A diversification of the international monetary system, currently dominated by the dollar, is not an optimal solution, to date. Many initiatives exist, however. For example, India is studying a rupee-oil swap mechanism to import Russian oil (and thus circumvent US and EU sanctions). The impact remains small, however.

With each new crisis, calls for an alternative to the US dollar abound. But neither the euro, nor the renminbi, nor the bitcoin can replace the greenback. Weaknesses in the institutional architecture of the euro prevent more massive adoption (this induces risks of monetary fragmentation between member countries, as was the case in 2012). The renminbi is not sufficiently internationalized (it is not freely convertible) and the recent events in China around the fight against Covid call for caution regarding Beijing’s openness policy. Finally, Bitcoin has all the characteristics of a risky asset, which evolves in concert with the American technology index Nasdaq. It is by no means a credible store of value in times of risk aversion. We remain in a world centered on the American dollar. The greenback currently constitutes 70% of foreign exchange reserves. It’s huge. We can deplore this, certainly rightly so. But there is no better solution than to put up with it.

It is up to the central banks of other countries to defend their currencies. Some have been doing so with undeniable success so far, often helped by rising commodity prices (Brazil’s Central Bank, for example). Others do it with more mixed success (European Central Bank, to name a few). The risk is that this defense of currencies will lead to what we experienced in 2011: a currency war.


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