HomeThe Race to the Bottom – Why Higher Inflation May Lead to a Stronger Dollar

The Race to the Bottom – Why Higher Inflation May Lead to a Stronger Dollar

For the first time in history, the economic recession affected the entire planet at the same time. Such an unprecedented situation generated by the coronavirus health crisis leads to a change in the way investors approach financial markets. 

Even during dark periods in humankind’s history, such as the two world wars, some parts of the world experienced economic growth. Not everyone was involved in the fights. Therefore, some currencies appreciated while others depreciated, mostly reflecting the economic differences between different parts of the world.

This time is different because all economies suffered from the health crisis. The global economy has a long way to recover to pre-pandemic growth, and all countries reacted in a similar manner – printing money via their central banks and eased in the fiscal space as well. Therefore, higher inflation is expected in all jurisdictions across the globe.

The Safety of the World’s Reserve Currency

Imagine a world where inflation reigns. Rising inflation means the prices of goods and services increasing exponentially. Not to be confused with hyperinflation, which refers to double- or triple-digit increasing rates.

The problem with this scenario is that exchange rates reflect the value of one currency in terms of another. In other words, for an exchange rate to decline, one currency appreciates against the other. Or, for an exchange rate to rise, there should also be a difference between the two currencies part of the exchange rate.

Therefore, in a world hit by inflation, where all currencies are debased, some will decline faster than others. Hence, the ones with a slower rate of decline will appreciate against the ones with a faster rate.

In this imaginary world, the U.S. dollar stands out from the crowd. The United States is better prepared to exit the pandemic as it is one of the leaders in the vaccination race.

Market participants will focus on the economy that first delivers the best results. Where will the recovery first be seen or accentuate if not in the world’s largest economy? Also, most of the world’s debt is issued in dollars, and the dollar’s share of international trade increased in 2020, despite many singing its demise.

The dollar does not have competition in the international arena. There is no direct challenger besides the euro, which comes in a distant second place, unable to challenge the dollar’s status.

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