ABSTRACT
It puzzles observers that an economic crisis in the United States strengthens the US dollar rather than weakens it. Figure 11.1 shows the US dollar index over the period 1973–2011. Six episodes of recession occurred during this time and in each event the dollar temporarily spiked up at least for some duration of the recession, bucking its secular trend of decline. The appreciation of the dollar in the advent of a crisis has been short term in nature and has inevitably reversed following the recession. This chapter seeks to explain the relationship of the dollar and economic crisis and explore the international linkages of US domestic policy. US policy toward the dollar appears to display rent-seeking behavior that is based on coercion of its international partners to accept the depreciation of the dollar. Such a policy is consistent with the behavior of a declining superpower rather than augmenting the status of the world’s lead currency. In a globalized world economy the fate of a currency depends not only on its issuer’s economic policy but also on its competitors, multilateral agencies, private corporations, banks and hedge funds. Increased integration with developed financial markets brought a series of crises in emerging markets (namely, the Tequila Crisis of 1994 and the Asian Crisis of 1997). These crises induced the developing nations to build dollar reserves by exports and investment in foreign equity markets through sovereign wealth funds. Globalization led to massive relocation of manufacturing to the labor surplus economies who in turn exported deflation to the developed economies by cheap imports and lowering of wages. The developed countries have responded with low interest policies that have fueled bubbles of stock and housing prices. Financial innovations and deregulation allowed excessive leverage and risk taking. Once “the robustness swung to fragility” (à la Minsky, 1974), the United States and with it the rest of the world was thrown into a severe economic crisis. Trade weighted US dollar index: major currencies (TWEXMMTH) https://s3-euw1-ap-pe-df-pch-content-public-p.s3.eu-west-1.amazonaws.com/9780203071939/f5926cb9-9b0b-4ba8-a181-685119a97bc9/content/fig11_1_C.jpg" xmlns:xlink="https://www.w3.org/1999/xlink"/> (source: Board of Governors of the Federal Reserve System). Note Shaded areas indicate US recessions.
