The U.S. Dollar index cycle: Depreciation coming?

AuthorDamir Tokic
Published date01 October 2019
Date01 October 2019
The U.S. Dollar index cycle: Depreciation coming?
Damir Tokic
Department of Finance, International
University of Monaco/INSEEC, Paris,
Damir Tokic, Department of Finance,
International University of
Monaco/INSEEC, Paris, France.
The recent U.S. Dollar Index countertrend rally will likely reverse to the longer-
term downtrend due to: (a) narrowing interest rate differentials, (b) rising
U.S. budget deficit, and (c) the geopolitical trend of dedollarization.
U.S. Dollar
The U.S. Dollar Index has been rising versus the basket of
major currencies since 2012. However, as illustrated in
Exhibit 1, the U.S. Dollar Index has been in a long-term
downtrend since 1973. Note, there have been two other
countertrend U.S. Dollar rallies, in early 1980s and late
1990s, both of which reversed to a structural longer-term
U.S. Dollar depreciation. Thus, if the history is any guide,
the current U.S. Dollar countertrend rally is also likely to
reverse. This article discusses the key variables driving the
U.S. Dollar in each countertrend rally, including the most
recent rally, as well as the structural variables causing
longer-term gradual U.S. Dollar depreciation.
The Bretton-Woods agreement, after the World War II,
established the U.S. Dollar as the global reserve currency,
under the fixed exchange rates regime. Specifically, the
value of U.S. Dollar was pegged to the price of gold,
whereas other currencies were pegged to the value of
U.S. Dollar. During the 1960s, due to the fiscal demands
related to the Vietnam War, and also increased spending on
social programs, it had become more difficult for the United
States to keep to the dollar-gold peg. Consequently, in early
1970s, the Nixon Administration effectively abandoned the
Bretton-Woods agreement and devalued the U.S. Dollar ver-
sus gold. Thus, in 1973, the U.S. Dollar Index was created
to track the value of U.S. Dollar versus the basket of curren-
cies of major United States trading partners.
However, the key U.S. policy objective at the time was
to keep the U.S. Dollar as the global reserve currency, under
the flexible exchange rate mechanism. Thus, the United
States engaged in a so-called oil-for-securityscheme with
Saudi Arabia, which resulted in the agreement to globally
invoice crude oil (and other commodities) exclusively in
U.S. Dollar, virtually ensuring insatiable global demand for
the U.S. currency.
After the Bretton-Woods system collapsed, the U.S. Dollar
depreciated, and inflation started to increase, as illustrated in
Exhibit 2, which shows the rising yields on U.S. Treasury
bonds (due to rising inflation) and the depreciating
U.S. Dollar in late 1970s. In fact, this represents a classic
example of a financial crisis characterized by a high inflation
and a collapsing fiat currency. However, in early 1980s, the
Treasury bond yields continued to rise, while the
U.S. Dollar reversed the course and started to appreciate.
Some observers attribute the U.S. Dollar strength to the tight
Volcker's Fed policy, and the loose Regan's fiscal policy,
combined with the broader neoliberal economic policies. In
fact, the bond yields started to precipitously fall toward
1980s, confirming the end of the inflationary crisis of 1970s,
which provided additional boost to the U.S. Dollar. How-
ever, U.S. Dollar also strengthen due to the widespread
Received: 20 August 2019 Accepted: 20 August 2019
DOI: 10.1002/jcaf.22413
J Corp Acct Fin. 2019;30:710. © 2019 Wiley Periodicals, Inc. 7

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