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

• Author: Damir Tokic
• DOI: http://doi.org/10.1002/jcaf.22413
• Published date: 01 October 2019
• Date: 01 October 2019

BLIND PEER REVIEW

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

Damir Tokic

Department of Finance, International

University of Monaco/INSEEC, Paris,

France

Correspondence

Damir Tokic, Department of Finance,

International University of

Monaco/INSEEC, Paris, France.

Email: dtokic@inseec.com

Abstract

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.

KEYWORDS

U.S. Dollar

1|INTRODUCTION

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.

2|THE U.S. DOLLAR INDEX

BACKGROUND

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-security”scheme 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.

3|THE FIRST U.S. DOLLAR SPIKE

IN EARLY 1980S

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;30:7–10. wileyonlinelibrary.com/journal/jcaf © 2019 Wiley Periodicals, Inc. 7