The US dollar is the world’s reserve currency. It’s solid and getting stronger, right? But did you know that for the world and the global economy, that’s actually bad? Here’s a little backstory.
In 1933, President Roosevelt disconnected the dollar from gold, discontinuing the possibility for anyone in the US to own gold in any fashion. He also forbade banks to pay out gold or to export it to prevent a run on the banks by consumers who’d lost confidence in the economy.
Since 1944, when 44 countries voted to create the IMF (International Monetary Fund) and World Bank, the US dollar has been known as the world’s reserve currency. This agreement is known as the Bretton Woods Agreement and officially made the US dollar the most trusted currency and allowed the US to export its debt much more effortlessly. It also made it easier for foreign central banks to deal in US dollars.
In 1971, President Nixon ‘temporarily suspended’ the convertibility of US dollars into gold, completely separating the dollar from gold and voiding the gold standard completely. This means that every time the US government prints money to pay its debt, it’s like writing an ‘IOU’ on paper. There’s no guarantee that the government will ever have the money to pay that IOU back.
Here’s Why That’s Bad
With inflation topping 9% in June and our national debt climbing past $29 Trillion, some economists say we’ve entered a new ‘dollar doom loop’ cycle. The dollar doom loop cycle is pretty common and always bad. We’ve gone through several in our history, and while it sounds nice because the dollar is strengthening, the global economy as a whole is shrinking, and that’s very bad.
So here’s the premise of a dollar doom loop. As manufacturing, commodities prices, and global trade all take a dip, worries about global growth set in and boom, America’s got a strong, solid dollar. To average citizens, that sounds like a great thing, the dollar’s strong, yay! But in the long-term, that’s bad news for the global economy, including the US.
When the US dollar is strong, meaning it’s at or exceeding historic levels in exchange rate with foreign currencies, it makes foreign countries sink further into economic troubles. Countries like China, Japan, and the UK lose value as the gap between exchange rates grows. In other terms, it takes more of their specified currency to make one US dollar.
Zimbabwe is suffering from such incredibly high inflation, topping a significant 200%, that their central bank has started printing gold coins for public purchase to try and steer clear of the US dollar. That fact alone explains how a severely strong US dollar spells ‘doom’ for foreign economies.
Short Term and Long Term Gains and Losses
Cecil Staton, a certified financial planner with Wealthtender and owner of Arch Financial Planning, LLC., said this about the short and long-term gains when it comes to a strong US dollar. “While many US consumers benefit from a strong US dollar when traveling abroad, their international investments may take a hit.
The stronger dollar hurts US investors investing in international and emerging markets funds to purchase securities in the local currency. The local currency used to buy the securities becomes weaker through a stronger dollar. As the local currency becomes cheaper, the value of your current holdings decreases.”
While a strong dollar can certainly be good news in the short term, the long-term outlook can be dismal as it pertains to a strong global economy. As the dollar strengthens against other foreign currencies, those currencies lose value. This means it takes more foreign currency to equal one US dollar.
For countries denominating their goods and services in local and US dollar currency, it means lost revenue. Lower revenue means less purchasing power, and countries never want less ability to purchase.
A strong dollar is also a financial pain for US corporations who sell or buy goods and services outside the US. Because most of their costs are denominated in US dollars, they lose considerable revenue in foreign countries where their goods and services are sold. For instance, Netflix lost $339 million, which equated to about 4% of their revenue, because of the exchange rate gap between foreign currencies and the US dollar.
Nearly 800 companies on the S&P 1500 lost money over the whole of 2021, and most plan to lose more revenue in 2022. The strong US dollar and exchange rates with other currencies are at least partly to blame.
Fixing the Problem
While weakening the dollar doesn’t sound like a great choice, it may be the only option in terms of global economic recovery. As August 2022 rolls in, the dollar has depreciated slightly, offering a mix of reactions worldwide. In the developing world, most countries welcome the depreciation of the dollar.
A weaker US dollar allows them to purchase goods, services, and trade while keeping more of their income. However, some countries aren’t so pleased when the dollar weakens. The Eurozone comprises 19 countries that have adopted the Euro as their official currency and sole tender.
Japan and several other countries aren’t keen on a weakened US dollar as most of their goods and services are denominated in the world’s reserve currency.
Fixing a dollar doom loop can happen in one of four ways. The first is for the Fed to cut interest rates to a level that allows for more purchasing power for the US dollar, causing foreign countries to regain some of their local currency’s value. However, inflation makes this one highly unlikely at the time of writing.
The second option is for growth outside the US to recover. However, with inflation sweeping the globe, this isn’t likely to happen, considering the US is sitting pretty to weather this inflationary period, and we’re still seeing record inflation numbers.
The third option is for China to stimulate its economy. This option has worked in the past to break a doom loop cycle and could hypothetically work again.
The fourth and most likely option is for commodities to fall in price. This option allows for freer manufacturing, trade, and purchasing activities, boosting countries currently manufacturing less and having to purchase more.
A dollar doom loop cycle doesn’t have to spell disaster for the US or foreign economies, but it is a precursor to how things can go from bad to worse. If central banks can’t get this figured out, everyone, no matter where they live, will be in for a long, hard climb out of this financial mess, and that’s if the US keeps its ‘world’s reserve currency’ status.
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This article was produced by Wealth of Geeks.
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