The dollar is gaining global hegemony for a once-in-a-generation momentum. Given that it has risen by 40% on a real effective basis over the past 11 years, some are starting to say that it may soon be lowered.
In the short term, it wouldn't be surprising for the dollar to fall. European countries are softening the economic fallout from the energy crisis, and central banks other than the United States are rapidly catching up to the Federal Reserve's interest rate hikes. Optimism intensified in the market on the 9th, and the dollar fell as money that had taken refuge in the safe haven asset flowed backward.
But it's clear that past long periods of dollar strength or weakness have been out of step with economic and monetary policy cycles. Something else is happening now. To explore the end of this dollar megacycle, we need to consider what it is.
Former U.S. Treasury Department economist Marvin Barth thinks it's all about innovation. His basic argument, who now runs the independent research firm Sigmatic Markets, is: America's leading position in academic research and close university-business ties have made the United States a leader in computerization in the 1970s and early 80s, the Internet in the 1990s, and most recently in modern Internet applications and artificial intelligence (AI). It means that they were able to cut the vanguard.
Each innovation sparked a wave of investment to keep it alive. This improved profitability, attracted foreign capital, and boosted the dollar as a result.
Inventions do not stay in one country for long. But in each case the U.S. led the way, gaining a lead of several years before investments elsewhere appeared to be paying off. By that time, the profits had spread throughout society and funded the consumption boom and the housing boom that followed. Even after losing its competitive advantage, the U.S. continued to siphon capital to finance housing construction. The dollar therefore needed to depreciate to levels that would be attractive to foreign investors.
This theory is excellent and helps explain why the dollar's long-term trend continues even during the temporary obstacles of a recession.
As evidence, Barth used engineering frequency analysis techniques to examine the cycle lengths of various economic variables. The cycle of business investment as a percentage of gross domestic product (GDP) matches the cycle of the dollar for about 17 years, but what matters in the short term (such as monetary policy) has little such long-term impact.
There is nothing strange about the length of the past cycle of 17 years, and there is no reason to think that the future cycle will be of the same length. The dollar's most recent rally has already lasted longer than any of the multi-year rises since the dollar was lifted off the gold standard by President Richard Nixon in the early 1970s.
Barth believes the dollar could continue to rise further because something interesting is happening with capital spending. U.S. private fixed capital investment (excluding housing) as a percentage of GDP has remained fairly high, helping the dollar avoid past cycles of rise and fall. The 10-year average is now the highest since Ronald Reagan left office, although private sector investment is often said to be inadequate. Moreover, the ratio of R&D investment to GDP is at a record high.
Moreover, deglobalization is likely to continue that cycle. With deglobalization, more capital will need to be invested in the United States to develop alternatives to international supply chains and to prevent the outflow of new developments.
Even investors who don't believe in innovation cannot deny that the United States has fared much better than other developed nations in rebuilding its economy after the financial crisis. The United States now has the advantage of being an energy powerhouse. This is also thanks to fracking, a US-led technological innovation.
“This cycle is driven by U.S. economic dominance,” said Kit Jax, head of foreign exchange strategy at Societe Generale, and the peak is likely to come soon.
In the short term, the dollar will be driven by the familiar issues of interest rates and recession fears. However, if the U.S. can maintain its economic vitality relative to other countries, the dollar could remain high for a long time.
