Dollar Hegemony Remains Strong Despite War... How Long Will the Strong Dollar Last? [Ukraine Shockwave⑥]

Neither the Euro nor the Yuan Can Catch Up to the Dollar's Status
Cryptocurrencies Rise Rapidly but Fall Short as 'Safe Assets'
In the Face of Pandemic, War, and Inflation... The Dollar Proved Stronger Against Adversities

[Image source=Yonhap News]

[Asia Economy Reporter Kim Hyunjung] Although there have been forecasts that the United States' 'dollar hegemony' in the international market would be challenged due to the Ukraine war, the dollar's position as the 'number one power' remains unshaken. This is the result of the Federal Reserve's (Fed) interest rate hikes aimed at combating steep inflation triggered by the pandemic and war adversities.

On the 7th (local time), the US Dollar Index (DXY), which measures the dollar's value against the currencies of six major countries, recorded 102.34, marking a 13.77% increase compared to the previous year. Although it slightly retreated after soaring to 104.62 on the 8th of last month, it maintains the highest level in over 20 years since 2002, except for May's figures.

Initially weak against the euro (European Union, EU), pound (United Kingdom), and yen (Japan) during the early COVID-19 pandemic, the dollar reversed to strength in 2021 and accelerated its appreciation following Russia's invasion of Ukraine in February. Over the past year, the dollar has risen 12% against the euro, 9% against the pound, and 16% against the yen.

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Challengers to Dollar Hegemony

The new Cold War dynamics triggered by the war have clearly hastened various challenges to the dollar's hegemony. Many countries have become aware of the need for alternative currencies to the dollar depending on the situation, prompted by Western economic sanctions on Russia.

Notably, Russia has sharply increased foreign exchange transactions in Chinese yuan and ruble to circumvent Western economic sanctions following the war.

According to Bloomberg News, last month in Moscow's spot foreign exchange market, the amount of yuan converted into rubles reached 25.91 billion yuan (approximately 4.81 trillion KRW), a 1067% surge compared to February. This reflects efforts by China and Russia to reduce dependence on the dollar and use their currencies as substitutes. Conversely, dollar-ruble transactions have dropped to their lowest level in about 10 years due to sanctions.

In March, Saudi Arabia began discussions with its largest customer, China, about settling part of its crude oil exports to China in yuan. As of 2020, China is the world's largest crude oil importer and accounts for 26% of Saudi crude oil imports. India is also considering using the yuan as a settlement currency when importing Russian crude oil.

Cryptocurrencies also pose a threat to dollar hegemony. Recently, US Treasury Secretary Janet Yellen mentioned the rise of Central Bank Digital Currencies (CBDCs) in a speech on digital assets, stating, "The dollar must maintain its status as the best currency in certain situations," signaling caution.

However, despite these challenges, the solid dollar hegemony stems from the United States' 'definite leadership' in international financial markets and military power, with no meaningful alternatives or challengers.

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According to the International Monetary Fund (IMF), at the end of 2021, the dollar accounted for an overwhelming 58.81% of global foreign exchange reserves. Although this is a slight decrease from 65% in 2009, the euro, the strongest challenger, saw its share drop from 28% to 20% during the same period. Within the international financial messaging network SWIFT, as of February this year, the dollar accounted for the largest share of transactions at 38.85%, followed by the euro (37.79%), pound (6.76%), and yen (2.71%).

The yuan, known as the most aggressive challenger to dollar hegemony, is indeed rapidly increasing its presence in the global currency market but is not yet threatening the dollar's dominance.

The yuan's share of global foreign exchange reserves is only 2.79%, and its share of SWIFT transactions is 2.23%. Stefan Monier, Chief Investment Officer at Swiss bank Lombard Odier, explained, "Even if the rift between the West and Russia becomes permanent and the world becomes increasingly multipolar, it will be difficult to see the dollar slipping from its dominant currency position. The yuan is a definite challenger to dollar hegemony, but there are almost no yuan-denominated assets that global investors can purchase."

Strong Dollar, a 'Double-Edged Sword' Even Within the US

The strong dollar phenomenon can help ease inflation, currently the biggest challenge for the US economy, by lowering import prices. However, it is a major adverse factor for multinational corporations with a high proportion of overseas sales.

For example, Microsoft lowered its revenue forecast for the fourth quarter of the current fiscal year (April-June) from $52.4 billion?$53.2 billion to $51.94 billion?$52.74 billion due to exchange rate fluctuations. The earnings per share forecast was also lowered from $2.28?$2.35, announced at the end of April, to $2.24?$2.32 within a month. US multinational companies like Microsoft must convert foreign currency earned overseas into dollars, and the sharp rise in the dollar exchange rate inevitably reduces actual profits. According to Bloomberg News, about half of Microsoft's 2021 fiscal year revenue was generated overseas.

Additionally, enterprise software company Salesforce also lowered its revenue forecast this year, citing the strong dollar as a cause, and Snap, the parent company of Snapchat, announced performance deterioration and hiring cuts, mentioning the macroeconomic environment. Luca Maestri, Apple's Chief Financial Officer (CFO), recently told analysts that the dollar is impacting Apple's quarterly revenue and is expected to have a negative (-) 3% effect on annual growth.

The strong dollar is also expected to have a greater impact on emerging markets where currency values have relatively declined. Mohamed El-Erian, former CEO of the world's largest bond manager PIMCO and economic advisor to global insurer Allianz, diagnosed, "In most (low-income countries), a strong dollar leads to higher import prices, increased foreign debt repayment costs, and greater financial instability risks," adding, "This will put even more pressure on countries that have already significantly expanded fiscal spending due to COVID-19."

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When Will the Strong Dollar Trend End?

So, when will the unstoppable strength of the dollar end? Experts predict that dollar demand will slow down once global financial market liquidity normalizes and economic growth returns to an average trajectory. In other words, the strongest sources of the current strong dollar are Europe's economic growth slowdown, China's COVID-19 lockdowns, and supply chain issues caused by the Ukraine war.

Stefan Monier, Chief Investment Officer, forecasted, "Once global growth begins to recover in 2023 and the Fed can ease aggressive rate hikes, a definite strong dollar depreciation will occur."

Some also speculate that the strong dollar will stop as US wage growth has slowed since last year and consumers are increasing savings, indicating signs of economic slowdown.

Inflation, the main reason for rate hikes, may also ease somewhat thanks to the strong dollar. While a strong dollar puts downward pressure on US exports, it simultaneously lowers import prices. Consequently, the US recorded a record trade deficit of $109.8 billion in March, a 20% increase from February.

The significant slowdown in US service sector growth last month and the largest drop in new home sales in nine years in April support this outlook. There is a possibility that the Fed will decide to slow the pace of rate hikes due to signs of economic slowdown, and investors in currency markets are expected to respond sensitively. Steve Englander, Head of North American Macro Strategy at Standard Chartered, explained, "The market sees the Fed as having reached its limit," adding, "Investors believe the dollar has passed its peak."

This content was produced with the assistance of AI translation services.