The Dollar King Crushes Everything – Are We Heading for the Same Situation As in 1985 With the Plaza Accord?
The hypothesis remains remote, but some already remember this major historical episode of the 80s.
“The dollar is our currency, but it's your problem.”
Richard Nixon's Treasury Secretary John Connally's phrase has never rung so true for almost every country on the planet.
In the face of geopolitical and economic uncertainties, the greenback is playing its role as a safe haven more than ever, attracting capital flows from around the world, and inflating its value, since to buy assets in dollars, one must first buy dollars.
On the other hand, other currencies such as the euro, the pound sterling, the yen, or the Chinese yuan suffer mechanical consequences, accentuated by the vulnerabilities specific to these economies. Against a basket of six major currencies, the dollar has appreciated by more than 21% over the past year. The traumatic threshold of parity with the euro, reached in the summer of 2022, is already a memory. On 26 September 2022, the euro reached a new 20-year low, just above 0.95 to the dollar. It has lost 17% against the greenback in the last year.
The momentum still has potential and we could see the euro's historic lows, around 0.85 in 2001, act as a magnet. The dollar is benefiting above all from a better economic outlook - less bad, in any case - in the United States and from the Fed's determination to continue raising rates. The martial speech of its boss, Jerome Powell, is pushing the markets to anticipate a key rate of at least 4.5% in the United States in mid-2023, which ensures a guaranteed return on risk-free bond investments.
Elsewhere, other central banks are forced to follow suit to avoid capital flight to the US dollar. However, the markets doubt the ability of the European Central Bank, which has only just started to raise rates in the summer of 2022, to go that far. First, because of the increased risk of recession in Europe, which is more exposed to the consequences of the war in Ukraine and the energy crisis.
Second, because of the inherent fragility of the eurozone. The risk of a new debt crisis, or even the break-up of the single currency, can never be completely ruled out. The victory of a far-right coalition with euro-skeptic overtones in the Italian elections keeps the doubt alive.
The British pound plummets
The crisis in the pound sterling also reveals a lack of confidence in the economic policy of the new government led by Liz Truss, which raises fears of uncontrolled slippage in public finances and unsustainable debt. The pound lost nearly 8% in two days, reaching an all-time low of 1.03 to the dollar, before recovering slightly on Tuesday 27 September 2022. Over a year, the decline exceeds 20%.
A hemorrhage that could continue due to the high volatility of the British currency. The Nomura bank sees it falling below 1 dollar by November 2022.
The Bank of England's efforts to chase the Fed with aggressive rate hikes may not be enough to turn the tide. Conversely, the ultra-accommodating monetary policy of the Bank of Japan, which remains the only one in the world to maintain negative rates, largely explains the collapse of the yen (-30% against the dollar over the past year).
This led the Japanese government to intervene last week in the markets to try to slow the depreciation of its currency. An operation that cost the Bank of Japan 20 billion dollars, but looks like a blow in the water.
Elsewhere, the Chinese yuan and most Asian currencies are down, due to the continuation of Xi Jinping's zero-interest policy which is weighing on Chinese growth. Everywhere, the rise of the dollar is increasing the cost of imports, especially raw materials, and oil, adding inflation to inflation. The improvement in the competitiveness of exports in mirror form is not enough to offset the economic cost.
How high will the dollar go?
As long as the Fed continues to raise rates, experts simply answer. But also as long as the American economic situation remains more favorable. It is hard to see how investors could start buying the euro again as long as there is no resolution to the war in Ukraine. The safe-haven role of the U.S. dollar is being maintained by the growing risk aversion in the financial markets, especially for equities.
The dollar remains the only major international reserve currency. The euro has not become a serious competitor. This largely benefits American geopolitical objectives, notably the weakening of China's trade. The currency weapon is undeniably effective. It remains to be seen to what extent the United States has an interest in this monetary disorder. These imbalances carry the seeds of systemic risks, the growing probability of defaults by over-indebted states, or the bursting of financial bubbles, such as the one in real estate in China.
In 1985, the Plaza Accord - named after the famous New York hotel - saw the United States, Germany, the United Kingdom, France, and Japan coordinate to stabilize exchange rates and control the value of the dollar.
Could the fact that the US dollar is crushing everything in its path lead to such agreements again in the months to come? For the moment, this hypothesis remains very remote, and there is little chance that such an intervention will occur, but it must remain in the corner of some people's minds if the situation continues beyond 2023.
Some reading
Make No Mistake, Our Real Enemy Is Inflation, Not Recession. Central banks even know that recession is the solution to the current problem with inflation.
Wall Street Is Falling? This Is a Choice That the Fed Fully Assumes. The “Greenspan put” is dead.
Elizabeth II: From the British Empire to the Disunited Kingdom. She leaves the throne to Charles III who should take up multiple challenges.
New Disillusionment for Donald Trump — Truth Social’s IPO Seems Compromised. As always, Donald Trump cries conspiracy.
There Is No Alternative — The Omnipotence of the USD King Has Been Confirmed More Than Ever in 2022. The reasons are multiple and have been highlighted with the war in Ukraine.