The dollar smiles — always

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The dollar smiles — always

Kim Pil-gyu
The author is a Washington correspondent for the JoongAng Ilbo.

Korean-American Kim Ji-sun, who lives in Virginia, felt she had earned money after visiting Korea. The dollar that had been at around 1,100 won last year shot up above 1,300 won in June. She felt she had saved money, but the 100,000 won that worth $93 was only $77 now.

Americans also felt lighter about vising Europe. One dollar bill exchanged for 1 euro last month. It is the first time the two exchange rates hit parity since 2002.

CNN and other media outlets reported Americans were returning home with luxuries and wines from European trips. According to an Allianz report in June, the number of Americans travelling to Europe this year is expected to surge 600 percent from last year thanks partly to the strong dollar, which has gained 15 percent against the euro. Some rich Americans are said to be on a shopping spree for mansions in France.

Americans can enjoy the luxury of a spending spree, unlike most other countries, thanks to the dollar smile phenomenon. The theory was coined by Stephen Jen, a former strategist in foreign exchange at Morgan Stanley, after the shape of currency fluctuations chart that goes up from both ends.

He claimed that the greenback tends to appreciate both when the U.S. economy is outperforming and when it is in a recession or the financial system under great stress. The U.S. Dollar Index (DXY), measuring the value of the greenback against a weighted basket of currencies used by U.S. trade partners, went up to the 107 mark last month, the highest in 20 years.

The strengthening of the dollar is due largely to aggressive benchmark rate increases by the U.S. Federal Reserve. The rate increases have added appeal to the safe assets of U.S. treasuries to spark capital migration to the dollar-denominated securities. The spike in natural gas prices from the Russian invasion of Ukraine that hit the European economies helped put the U.S. economy in better light, contributing to stronger dollar, according to Kenneth Rogoff, an economist of Harvard University.

The dollar’s smile, however, has not made other economies happy. The strong dollar has made other countries spend more of their currencies to cover for the debt in dollar denomination and pay for imports in the greenback, observed Daouda Sembene, a former executive director of the International Monetary Fund.

Emerging economies with high external reliance have seen their currencies sharply depreciate against the dollar. Sri Lanka defaulted on its debt in May after it came ran short of foreign exchange reserves.
Korea also has been hit hard by the strong dollar. Inflation has worsened, as strong dollar has made imports more expensive. The faster rise in interest rates to help calm the soaring exchange rate has aggravated debt financing woes for households.

The cheaper won helps exports by making Korean products price-appealing on the U.S. market. Given Korea’s economic fundamentals, foreign exchange levels, and growth rate, it may be premature to raise the alarm about a financial crisis as in the scale of the past two major crises. “The key is the flight of foreign capital from the Korean market, but it has been a different case as in the past,” said Kim Suk-won, head of the Washington office of the Bank of Korea.

Two factors can tame the dollar. The first is the end of the Ukraine war. When the energy crisis from the invasion eases and the euro strengthens on removed uncertainties, the dollar preference could weaken.

Second, the U.S. economy could recede from a jump in interest rates. Upon a recession next year, the Fed could shift back to loosening policy. When foreign investors cash out of U.S. assets, the dollar would lose its value.

But an overly fast economic contraction could bring about another shock to the economy. Developing economies have been sustaining growth through exports to the U.S. But if the U.S. economy retreats, their growth also would be at stake. Swiss investment bank UBS warned that the emerging markets could face bigger pain if they lose exports.
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