Why Is the Dollar Crushing Global Currencies if Inflation Is so Bad?

The continued dominance of USD in global markets may come as a surprise to those who learned economics from crypto.

AccessTimeIconSep 28, 2022 at 4:08 p.m. UTC
Updated May 11, 2023 at 6:12 p.m. UTC
AccessTimeIconSep 28, 2022 at 4:08 p.m. UTCUpdated May 11, 2023 at 6:12 p.m. UTCLayer 2
AccessTimeIconSep 28, 2022 at 4:08 p.m. UTCUpdated May 11, 2023 at 6:12 p.m. UTCLayer 2

While the declining domestic buying power of a dollar dominates headlines in the United States, American inflation is having a surprising impact around the globe: Nearly every major currency has fallen dramatically against the dollar over the past six months. That seems like a challenge to the relentless focus on monetary supply that is widespread among cryptocurrency adherents.

China’s yuan has lost 12% against the dollar since April, and traditionally stronger currencies including the euro and yen have seen similar drops. Controversial financial decisions by new U.K. Prime Minister Liz Truss have driven the British pound down even more sharply in recent days, for a cumulative 18% drop since April.

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These moves may be particularly surprising for those whose financial thinking has been shaped by discussions in cryptocurrency circles. You might argue the tail has wagged the dog on crypto’s understanding of inflation: Bitcoin’s fixed supply has been aggressively marketed as a long-term inflation hedge, leading to an emphasis on so-called monetary inflation. Monetary inflation occurs when more monetary units compete for the same amount of real-world goods, driving prices up. Or, as a coronavirus pandemic-era meme elegantly simplified it, “money printer go brrrrr.”

But if the money supply were the beginning and end of the American inflation story, the dollar should be losing value against world currencies. The U.S., after all, had the second-largest fiscal response to the COVID-19 crisis of any industrialized nation, much of it debt financed. But if America has been borrowing and printing more money than Japan or China, shouldn’t the yen and yuan be gaining relative value on global markets?

Answering this seeming conundrum points to a more nuanced view of inflation than bitcoiners’ Austrian Economics-driven monetarism on several levels. Data from the Economic Policy institute shows that inflation has been similar worldwide over the past year-plus, with little correlation to either pandemic spending or post-pandemic recovery as measured by unemployment levels.

Based on that data, EPI argues that supply chain disruptions, rising commodity costs and shifting consumption patterns are more to blame for inflation than the money printer. That is, the problem isn’t too much money but too few goods, in the wrong place.

Flight to safety

Meanwhile, what’s directly hammering dollar exchange rates is a more technical second-order impact of rising prices in the U.S. As Jerome Powell and the Federal Reserve raise interest rates to fight domestic inflation, American dollars and Treasury instruments become far more attractive investments. That’s part of why U.S. stocks are dropping, and the same dynamic is encouraging investors worldwide to swap from yen, euros, pounds and yuan into dollars to reap the 4% low-risk yield on the two-year Treasury bond.

That’s where a third factor enters the explanation – and one with serious lessons for those thinking about finance in crypto.

There are other currencies offering much bigger bond yields than the U.S. – Turkey’s two-year yield is over 13%, for instance. But as depositors in LUNA’s Anchor protocol found out when that system collapsed in May, yield ain’t nothin’ but a number. Thirteen percent on Turkish lira is still a hard sell versus 4% on U.S. dollars because of the greater global faith in the fundamental productivity of the U.S. economy, and the responsible management of the U.S. currency.

While U.S. dollar bonds are considered to bear near-zero risk of default, bondholders of countries with either wobbly real economies or questionable financial leadership must add the risk of default into their calculus.

The current looming fear of a global recession only accentuates that dynamic: Even in the absence of inflation and U.S. rate hikes, we would probably be seeing greater dollar strength merely as a function of the “flight to quality” that consistently follows economic uncertainty.

This is a vital take-home for an industry and investors fundamentally oriented around building new currencies. The bull market saw a lot of competition to offer depositors the highest percentage return, often in manufactured tokens like LUNA, CEL or MIM. But those tokens, not entirely unlike the lira or now even the pound, were built on shifting, uncertain foundations by leaders who were not trusted by close observers.

Those deep and holistic structural weaknesses, not merely their numerical supply, was ultimately what led to collapse. When the going gets truly rough, in other words, faith in a currency may have more to do with quality than quantity.

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David Z. Morris is CoinDesk's Chief Insights Columnist. He holds Bitcoin, Ethereum, and small amounts of other crypto assets.