One of the biggest financial news stories of 2022 has been the remarkable ongoing strength of the United States dollar. If we look at the popular and widely quoted U.S. Dollar Index (DXY), as of mid-September, it was up by over 18% in the last 12 months, with about 14.4% of that occurring just in 2022 alone. Indeed, the top story in Wall Street Journal on September 19 was about the “once-in-a-generation rally” in the U.S. Dollar, and the stresses this was putting on the global financial system. This is true – but it isn’t the whole truth. What we are seeing isn’t extraordinary strength versus the rest of the world. Instead what we are seeing is the extraordinary weakness of the closest allies of the United States, the other economic powers that make up the West. In this analysis we will dig into what the dollar index rally really measures, and take a look at what is actually happening with the currencies of the West versus the currencies of the BRICS+ nations.
Crushing Our Closest Allies
The “once-in-a-generation” rally in the dollar definitely fits the usual narrative about the dollar being the world’s reserve currency. During crisis, it is supposed to soar in value relative to other global currencies in a flight to safety. The other nations of the West are also supposed to benefit, as money from South America, Africa and Asia all flows into the secondary reserve currencies of the euro and the yen.
This increase in the value of the dollar means that imports cost less for the United States, reducing the rate of inflation, while the costs of imports jumps upwards for the developing nations, increasing their rate of inflation. In crisis then, the way the global order has been set up by the West is that the developed nations effectively pass some of their inflation onto the less developed nations. However, that isn’t what is currently happening, we are seeing something quite different.
While the “U.S. Dollar Index” and related indexes sound quite global – they generally are not. Their purpose is to measure the strength of the dollar versus our traditional six largest trading partners, not the world as a whole. The ICE U.S. Dollar Index (DXY) therefore weights the euro at 57.6%, the yen at 13.6%, and the pound sterling at 11.9% (with Canada, Sweden and Switzerland having lesser percentages). When we say that the dollar is up 14% year-to-date then, we’re not saying the dollar is up versus the world, but rather the dollar is up sharply versus our most important allies in the West, the 83% of the index that is made up of the euro, the yen and the pound.
- The main source of the dollar being up by 14% this year is that the Eurozone countries have been getting hammered, their 57.6% of the Dollar Index has lost almost 12% of its value versus the dollar (as of 9/9/22, it has since deteriorated further).
- Japan is getting hit even harder, with the yen having lost almost 20% of its value.
- The United Kingdom is also reeling, with the pound having lost about 14% of its relative value.
- Most of the European nations with their own currencies are experiencing similar very poor results, including Denmark, Hungary, Norway, Poland and Sweden.
As a result of the U.S. led sanctions then, the West is experiencing a major decline in the value of its currencies, with the euro now hovering at the parity level with the dollar (and falling below parity with the Russian mobilization announcement). Another way of phrasing this is that the United States is successfully exporting inflation to its closest allies, as the cost of imports in the U.S. falls, even while the cost of imports in the allied nations rise.
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How about the rest of the world?
The best known opposition is the BRICS, or BRICS+, and they include Brazil, Russia, India, China and South Africa. They have been trying to achieve a multipolar global financial system that is not dominated by the U.S. dollar for two decades now, and they are currently being joined by such nations as Saudi Arabia and Iran. Collectively, they account for close to half of the world’s population, they control extraordinary physical resources, they have vast manufacturing capabilities, they include some of the most powerful nations in Asia, South America, Africa and the Middle East, but yet, under the existing system, they have much less financial wealth than the West…
The BRICS are much less of an alliance than is the West as they have their own issues and internal divisions, particularly between China and India…but they do have a common interests in seeking a world that is not financially dominated by the West…
If we take a simple average of the currencies of the three leading Western Allies, then they have lost 15.1% of their value versus the dollar and, if we…[exclude] the dollar then,…their currencies lose about 16.1% of their value relative to the six BRICS+ nations.. If we take a simple average of the six BRICS+ currencies, they have gained 1.2% relative to the dollar. Why are their currencies doing so well relative to the traditional economic powers of the West? That does not fit the narrative for how crises are supposed to work, the Wealth of the West is supposed to be dominant. How can this be?…continue reading