On Monday, U.S. Treasury Secretary Jack Lew hosted a meeting in the offices of the American Federal Deposit Insurance Corporation, FDIC. The attendees, Federal Reserve Chair Janet Yellen, British Chancellor of the Exchequer George Osborne and Mark Carney, governor of the Bank of England, came together to protect an imaginary world from ruin with their heroic actions.
The distinguished quartet went to the FDIC to run through a simulated emergency scenario: the failure of a bank that cannot be allowed to fail. The exercise was intended to shed light on whether the world can cope with a second Lehman shock.
The world’s most powerful leaders haven’t forgotten that horrific experience. The global economic system suffered permanent damage as a result of its near collapse. The economic recovery has remained stuck in a “new mediocre,” as the International Monetary Fund puts it.
The world economy is losing steam once again. Europe’s economies are flagging, and emerging economies have overspent during their growth marathon. Only the United States has cured its financial infection. Household debt levels are sinking, the government deficit is shrinking and the IMF has elevated its prognosis for U.S. growth.
The dollar is an insignia – perhaps the insignia – of American hegemony.
The United States is “the last big economy still showing signs of strength,” said Eswar Prasad, an economist with the Brookings Institute. Anyone who doesn’t believe this should take a look at exchange rates. The dollar has strengthened considerably against its key competitors since the summer, and currency strategists expect it to continue going up in value. The dollar could reach parity with the euro by 2017.
This presents an important lesson for Mr. Lew and the players in his financial war game. The paradoxical outcome of the Lehman fiasco is that it didn’t weaken but in fact strengthened the dollar. The dollar is like a dynamo: the greater the friction in markets, the brighter its light.
The U.S. currency has been written off before, and its decades-long dominance has been declared the original fiscal disaster. And yet the dollar continues to dominate global payment transactions. The U.S. currency is used in 87 percent of all currency transactions, a market with a volume of $5 trillion (€3.92 trillion) a day.
What other currency could challenge the dollar? The Chinese renminbi? Not as long as China is ruled by a despotic government. The euro? Only when Europe enters into a political union – in other words, probably never.
The dollar is an insignia – perhaps the insignia – of American hegemony.
Germans have periodically questioned its dominance, while the Chinese have sought to combat it. “The United States will lose its status as the superpower of the global financial system,” then-German Finance Minister Peer Steinbrück said a few days after the Lehman bankruptcy.
The prevailing strength of the dollar only becomes evident when contrasted with the weaknesses of other world regions. Most Americans have derived little benefit from the economic recovery. Incomes have stagnated, part-time work is flourishing and the growing affluence of recent years has only benefited a narrow upper class. Some 72 percent of U.S. citizens believe their country is in recession. But why should this trouble investors, if Europe and Japan are stuck in even deeper crises?
The dollar’s special role as the global reserve currency enables Americans to live beyond their means. Economist Jacques Rueff has noted that the United States can afford chronic deficits in its national budget and balance of trade “without tears.”
The indestructibility of the dollar can be attributed to a contradiction. Like any financial crisis, the great crash triggered a wave of capital flight – paradoxically, however, it wasn’t moving away from but toward America. That’s because only the American financial market is big enough to offer panicky investors options that are both safe and liquid: U.S. treasury bonds. Brookings economist Mr. Prasad calls this “the dollar trap.” Precisely because of the vulnerability of the global financial system, it is difficult to shatter the dollar’s dominance. In fact, each new crisis only makes the greenback stronger.
At the height of the global recession, the U.S. deficit increased nearly to Greek proportions. But interest rates fell and hardly anyone in the markets questioned the country’s creditworthiness. This was partly because the Fed launched three programs to buy up treasury bonds and other securities, pumping a total of $3.2 trillion into the market in the process.
Emerging economies, worried about their ability to compete, then tried to prevent their currencies from becoming more expensive against the dollar. This prompted them to print more pesos, real or renminbi and buy U.S. treasury bonds. Now they find themselves stuck in a trap: Precisely because they own so many dollars, they have an interest in preserving the dollar’s position as the reserve currency. Some 60 percent of global currency reserves are held in dollars. This scenario highlights the true absurdity of the global money economy: The Chinese, of all people, are paying directly to maintain the U.S. Navy, by which they feel surrounded.
A weak euro is good for Europe, which also makes it good for the United States, because Europe is an important trading partner.
To some extent, the strength of the dollar is also a reflection of the weakness of the euro, which almost all U.S. investors and economists believe is the goal of European Central Bank President Mario Draghi, even though ECB statutes prevent him from admitting it. Many economists also believe that a weak euro is good for Europe, which also makes it good for the United States, because Europe is an important trading partner.
Jürgen Fitschen, the co-chief executive of Deutsche Bank, doesn’t see “that my counterparts are very worried about the strong dollar. The Americans’ optimism is unbroken, and Europeans are also investing in the United States.” Still, Mr. Fitschen is more skeptical when it comes to the impact of a weak euro: “It would mostly benefit Germany, but it could also intensify tensions in the euro zone.”
Marc Chandler of BBH, a private U.S. bank, points out that, according to a model created by the Organization for Economic Cooperation and Development (OECD), many other currencies are still greatly overvalued against the dollar: the Swiss franc by 31 percent, the Australian dollar by 24 percent, the British pound by 10.5 percent and the Canadian dollar by 9.5 percent.
The strengthening greenback also benefits the competition. Fabrice Brégier, head of Boeing competitor Airbus, said the aircraft maker incurs 90 percent of its costs in the euro zone but sells 90 percent of its products in dollars. He has argued for a targeted devaluation of the euro to between 1.20 and 1.25 against the dollar – a wish that has now been fulfilled.
Mr. Brégier isn’t alone. Until recently, Germany’s many export-oriented companies were suffering from the strong price of the common currency. In addition to raising prices in the dollar zone and worsening competitive conditions, it also lowered profits and revenues when companies converted their balance sheets into euros.
What happens next with the dollar depends on how the Fed proceeds. Will it truly initiate a phase-out of the policy of cheap money in the coming weeks and months? Or will it soften up again? Anyone looking for answers is likely to encounter new questions first. The big question – would a stronger dollar hurt the U.S. economy?
It seems clear that the strong dollar could exert pressure on the U.S. economy. But the effects are not measurable yet, nor do they trouble American economists and investors.
While a strong dollar could squelch U.S. growth, a stagnating euro zone could do the same. In 1971, then-U.S. treasury secretary John Connally told a foreign journalist: “The dollar is our currency but it’s your problem.”
But if the euro zone slides into recession, the tables could be turned and the rising dollar – a boon for U.S. consumers but a bain for its exporters – could become a problem.
That’s why Washington has urged euro zone governments to spend more to stimulate growth. If not, the new American refrain might be: “The euro is your currency, but it’s our problem.”
Thomas Jahn is New York bureau chief for Handelsblatt, Frank Wiebe is correspondent for Handelsblatt in New York and Moritz Koch is Washington correspondent for Handelsblatt. Siegfried Hoffmann, Georgios Kokologiannis, Thomas Ludwig and Ulf Sommer also contributed to this article. To contact the authors: email@example.com, firstname.lastname@example.org, email@example.com