The Exceptional Qualities That Set the US Dollar Apart
The long-term strength of the U.S. dollar is primarily influenced by two key factors: investor demand and global savings patterns, according to a study by researchers led by Zhengyang Jiang, an associate professor of finance at Kellogg.
1. **Investor Demand for the Dollar**
This is the most significant factor, explaining about 55% of the dollar’s strength. When companies, countries, and global investors consider the dollar a desirable asset, they increase their holdings of U.S. currency and dollar-denominated securities, thereby appreciating its value. This demand reflects confidence in the dollar as a stable store of value and safe investment. Major holders such as China, which owns hundreds of billions in U.S. Treasuries, play a critical role. Sudden changes in demand from such large holders could dramatically impact the dollar’s value.
2. **Global Savings Patterns**
Global savings, accounting for about 36% of the dollar’s long-term strength, influence the currency’s value because more savings held in dollars means sustained demand. When the world saves more in U.S. assets, it strengthens the dollar’s reputation and purchasing power internationally.
Other factors, while important over shorter periods, have a less lasting impact on the dollar’s long-term strength. Monetary policy, economic growth, geopolitical events, inflation trends, and yield advantages contribute to the dollar’s relative attractiveness but typically influence the dollar’s value more in the short to medium term.
The researchers used a valuation model based on two decades' worth of data from the International Monetary Fund to break down the strength of the dollar. The model shows that a widespread dip in demand for U.S. assets could cause the dollar to depreciate by 25%. The demand for U.S. assets is particularly elastic, with foreigners having a high willingness to substitute towards those assets when they're available at a discount.
The model also suggests that a severe depreciation of the dollar could occur if demand for U.S. currency slackens across many countries. For instance, a unilateral sell-off of U.S. assets by one country or major economic bloc would depreciate the dollar by 2.5%, 1% (for Japan or Canada), or a similarly low amount (for the entire European Union).
In the past, the value of the U.S. dollar has fluctuated, with a similar drop observed in 2017. The researchers' model assumes that countries and financial institutions view the U.S. dollar as an investment asset, like stock in a company. Global confidence in Treasury bonds has likely diminished the dollar's specialness in the international financial market.
Interest-rate gaps between the U.S. and other countries tend to converge over the long run, lessening their impact on enduring dollar strength. The researchers applied their model to data from the International Monetary Fund, tracking currency exchange rates, dollar-based asset prices, and portfolio allocations between 2002 and 2021.
In conclusion, the U.S. dollar’s long-term value is shaped mainly by global investor demand and international saving behavior, which underpin its reputation as a global reserve currency and store of value. While other factors are important, they typically influence the dollar’s value more in the short to medium term. Sudden shifts in demand or large-scale changes in global savings patterns can therefore cause significant long-term fluctuations in the dollar’s strength.
- The increased demand for U.S. assets by global investors, including major holders such as China, drives the strength of the dollar, constituting about 55% of its long-term stability.
- International savings held in dollars contribute to its long-term strength by around 36%, as more savings in U.S. assets strengthens the dollar’s reputation and purchasing power globally.
