Why Other Currencies are Falling Against the US Dollar?

It is not merely because the US dollar is the global reserve currency. There is a more technical thing going on here. And you might want to factor it into your long-term investment strategy.

First, let us understand what exactly is happening with the weaker currencies.

The JPY Case Study

Almost every currency is weaker against the dollar thus far in 2024. The euro is weaker, the pound is weak, and the Swiss franc too. However, the more profound weaknesses are those found in Asian economies and emerging economies.

The Japanese yen has been in the spotlight in the last couple of weeks. The Bank of Japan ended its yield curve control and hiked interest rates for the first time in more than a decade.

Now, yield curve control means if the weakness of the yen gets to a particular level, the Japanese central bank will intervene by buying more yen to keep the yen steady. We have seen this in the past when the yen moves towards 150 (to the dollar), the price will go back down. This is often the central bank's intervention.

However, the yield curve control program has been suspended. And thus, the dollar-yen is currently about 154. This means 154 yen equals 1 usd.

This impacts the prices of goods and services all over Japan. It also affects the pricing of Japanese imports and exports. When a currency is weaker, it can buy less. And that is one of the tenets of inflation.

Japan is one of the countries that prides its economy on stable pricing. With the yield curve control off and the Bank of Japan raising rates for the first time in almost 2 decades, there will be some effects. Why is the yield curve control off?

Every time the Bank of Japan intervenes with yield curve control, they sell their dollar reserves. And they resort to doing this as opposed to raising interest rates, as there is no domestic pressure to raise rates. So, what changed?

There were a lot of little changes. A lot started happening with the dollar and in the global economy. But much more importantly, there were significant wage increases within Japan.

Wage increase is one of the things economists look out for when studying inflation. But when you think about it, it is very funny and ironic.

The workers "fought" for wage increases and got it. Then, the BOJ (Bank of Japan) raised interest rates which increased the cost of borrowing money for businesses. Meaning that businesses now have to make the same amount of money (perhaps even more) with less capital. And that means they have to increase prices or risk running out of business.

This is the big picture of what is happening. And it can trigger a never-ending inflation loop. But the worst of it is not Japan.

The Vietnamese Dong is under pressure too. The Nigerian Naira went through hell in the first quarter of 2024. Several other currencies have been badly beaten thus far - the Turkish Lira, Argentina's peso, and even the famed Chinese yuan.

So, it is not so much what is happening in these other countries. They are all weaker compared to the US dollar. Now, let's look at why.

Exported Inflation

The modern problems began in 2020 during the lockdowns. The Fed (which is the central bank of the USA) printed a lot of money to backstop the stalled economy. It is rumored to be over 10 trillion. And some even suggest it is much more.

That money, of course, found its way into the stock market. This is where the market contradiction started. The stock market was at all-time highs while many businesses were closed and most struggled.

The correlation between the stock market and the real economy has been broken since then. Money flowed into circulation and everybody was making money.

The warnings about inflation started to surface. And the Fed and Treasury both said that inflation is transitory. Meaning that it is a phase. After a while, they believe inflation will "normalize" back to 2% without any policy action.

That turned out to be a false assumption. Today, after multiple rate hikes by the Fed, the inflation stays within the 3-4% range. And there is no clear indication that it is coming down.

But even that inflation range is lower than what printing 10 trillion usd should have caused. And the secret is simple - there is a global demand for USD.

As inflation picked up in other countries due to the disastrous lockdown policies and prices of goods and services rose, people looked to ways to beat the inflation. And the best answer is to store money in USD.

This gave rise to surging USD demand in other countries. And many central banks were struggling to keep up, using their dollar reserves. Meanwhile, the Fed has been raising interest rates to battle domestic inflation but this has led to a stronger demand on the international market.

Higher interest rates on the dollar means the cost of borrowing the dollar is now higher. If the cost of borrowing the dollar is higher, then the dollar has more value to the one that has it, to the detriment of the one that needs it (and wants to borrow).

As the cost of borrowing gets higher (and stays high), other countries that need dollars to transact (and don't have it) will have to pay more. And we know that 99% of global transactions are settled in USD. So, the international demand for USD will always be there.

In other words, among world currencies, there is no reasonable case for a weak dollar regardless of how much is printed. Among commodities, however, the dollar suffers from progressive weakness.

The dollar devaluation story is with respect to commodities, goods, and services. To other countries, they will only devalue faster. If the dollar should go into hyperinflation today, not less than 70 countries of the world would see their currencies wiped out.

Many of them keep reserves in usd. That tells you all you need to know. Yes, some currencies are typically stronger than the usd, such as the Kuwaiti Dinar. But if you take those currencies out of their respective countries, there is no demand for them.

International demand for the US dollar makes other countries' currencies perpetually weak to the dollar. In fact, most countries don't want strength. They just want stability.

Everybody knows this. So when stability is becoming difficult to attain and start doubting the system, everyone tries to flee to safety. And safety is the US dollar. Why? Anywhere you take the US dollar, it will be accepted.

Conclusion

The US is making it more expensive to borrow the US dollar. They are trying to use that to curb domestic inflation. But the side-effect of this is a stronger dollar with respect to other currencies (and not necessarily commodities).

Keep this in mind as you invest. This is important to note when investing in other countries (especially emerging economies). Store of readily accepted money with the best liquidity is still the US dollar. And for that, it will remain strong relative to other currencies.

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