The Dollar Is Still King in Europe, and It’s Swaying Interest Rates U.S. currency remains critical to European inflation and growth By Tom Fairless May 28, 2023 12:01 am ET 27 The dollar has lost little of its global dominance despite some countries’ push to use other currencies. Photo: Kerem Uzel/Bloomberg News FRANKFURT—It’s not just Americans watching anxiously to see if the Federal Reserve raises rates or the U.S. slides into recession; so are Europeans, and indeed many other countries. That’s because for all the talk of deglobalization and de-dollarization, the dollar still reigns supreme, and financial and trade ties between the U.S. and key partners are as strong as ever. In Europe’s case, they’re even stronger. The European Central Bank tried to chart a different path from the Fed early last year, signaling it would hold rates low as the Fed raised them aggressively. But after the euro slid against the dollar, ECB officials quickly reversed course over fears of imported inflation from goods like energy that are invoiced in dollars. The challenge now is the opposite. Fed officials have signaled that they will pause raising rates at their June policy meeting to see if the 5 percentage point increase since early 2022 significantly slows the U.S. economy. That might make it harder for their European counterparts to raise rates a few days later, despite stubbornly high inflation. “The dollar does play a dominant role in the global economy,” said Maurice Obstfeld, a former chief economist of the International Monetary Fund. “The rhetoric coming from the ECB [last year] indicated concern about the exchange rate.” Talk of the dollar losing its reserve currency status has risen with moves by Saudi Arabia, China and Russia to use other currencies. That’s in response to the U.S.’s use of the dollar as weapon, such as freezing Russia’s currency reserves in response to its invasion of Ukraine. The dollar accounted for less than 60% of official foreign-exchange reserves in the second quarter of last year, down from about 72% two decades ago. Advertisement - Scroll to Continue And yet to date, the dollar has lost little of its global dominance. SHARE YOUR THOUGHTS What’s your outlook on the global economy? Join the conversation below. While the U.S. accounts for around one-quarter of global output and just over 10% of global trade, roughly half of global trade is invoiced in dollars, and the greenback was involved in nearly 90% of global foreign-exchange transactions last year, a share that has changed little in 20 years, according to a December report by the Bank for International Settlements. About half of all international debt securities and cross-border loans issued in offshore funding markets are denominated in dollars. These linkages transmit higher U.S. interest rates to foreign economies in several ways. They draw capital out of other economies, pushing up borrowing costs and causing currencies to depreciate against the dollar. About a third of the change in U.S. money market interest rates in response to Fed tightening is passed through to equivalent German rates, according to ECB research. As the dollar rises, dollar-denominated commodities such as oil become more expensive in foreign-currency terms. In the other direction, higher rates slow U.S. growth and, eventually, demand for foreign products. All of that means the Fed’s interest-rate increases affect Europe’s economy as much as—or even more than—they do the U.S., according to ECB research. Fed tightening between 1991 and 2019 reduced the eurozone’s industrial output, stock prices, business loans and inflation rate, and weighed on world trade outside the U.S. Conversely, the ECB’s actions have minimal impact on the U.S. economy, the research suggests. ECB officials watch the Fed’s policy actions very closely and monitor the euro-dollar exchange rate, although they say it isn’t a policy target. “When the Fed takes the lead, others will follow without hesitation,” said Panicos Demetriades, a former ECB official who was governor of Cyprus’s central bank. To be sure, the ECB and other overseas policy makers aren’t just following the Fed. They are doing similar things because inflation everywhere is far too high, driven by common global shocks, from the pandemic to the war in Ukraine. “You know the currency, for instance, has an impact, any spillovers will be taken into account, but we are not Fed-dependent,” ECB President Christine Lagarde said at a news conference in early May. “We have more ground to cover, and we are not pausing.” With its policy rate roughly 2 percentage points below that of the Fed, the ECB has space to catch up, said Obstfeld. But whether the ECB in fact does keep tightening will depend on whether the Fed has pushed the U.S. into recession. For Europe, exports—especially to the U.S.—have been a rare source of strength as the war in Ukraine saps households’ purchasing power. Trade in goods between the EU and the U.S. increased to $86 billion in March, up around 8% from a year earlier. America’s trade in goods with China declined by around one-quarter during the same period, to $45 billion in March, according to data from the Census Bureau. If the U.S. falls into recession in coming months, America’s imports will likely decline, removing a vital growth crutch for Europe. Still, the dollar would likely weaken, lowering European energy prices and imported inflation. Overall, a hard U.S. landing would likely make life harder for Europeans—but potentially easier for the ECB. “Europe in general is in a pretty precarious state…that will instill some caution in the ECB,” even if there is political pressure to bring inflation under control, said Obstfeld. https://www.wsj.com/articles/the-do...ying-interest-rates-179f01e5?mod=hp_lead_pos4
With the fed rushing $3.1 billion to Switzerland, I would say no consideration of this topic is complete without considering the issues related to banking. I get feeling that there's a potential crisis over there, but I don't know enough to put my finger on it. I get the impression that regulators are deliberately ignoring weak banks and that it took a massive outflow of deposits to force the issue at Credit Suisse. I know I'm nervous about the money that I have tied up in European financial institutions. If I didn't have minimum holding periods to worry about I would be getting everything out of Europe and back to US institutions.
Do you really think that Europe is going to get its finances in order better than the US? (Serious question) The way I see it the Euro is doomed. Over a dozen countries sharing a common credit card account... There's no incentive to get one's house in order. I don't think it will go out right away, but more gradually. It could take decades. It will become less and less valuable vs other currencies and then Europe will panic and implement capital controls which will make the situation 10x worse.
The issue the rest of world has with the dollar isn't that it's the currency king, it's that the US government uses it as a political tool when it suits its political agenda, and manipulates its value against other currencies when it suits its economic agenda. In effect, the US government manipulates their currency like other nations do, when the rest of world expects the US to remain neutral in all instances.
I been using same long term commodities system since mid 1991, although it is generally very early, takes many trades to find extremes, hedges most positions, it does finds tops/bottoms. It adds on to positions which also takes many tries till they hold. I have learned opinions don't matter, system is short U.S.Dollar from highs last year and long most currencies, almost all positions hit first target and has breakeven stops. I have tested hundreds of long term systems in past 30 plus years, this one works for me. In most markets it uses hedges and risk is very low. Often times system makes overall profits cause of hedges of losing future trades. Opinions don't matter, just the bottom line for me.