Image source: forexcrunch.com

“Remember the currency wars? They were about the notion, popular over the last few years among financial commentators and not a few global policy makers, that the nations of earth had become locked in a pattern of debasing their currencies in pursuit of a momentary economic advantage, a race to the bottom that would end in tears for all.”  –Neil Irwin  (The New York Times)

Since 2008, and especially in 2011 when the Fed announced its controversial bond buying program called “quantitative easing,” there has been a consistent theme in the financial media that the central banks across the globe were locked in a furious race to see who could destroy their own currency first. The logic goes something like this: all the major developed countries were running substantial deficits and accumulating mountains of national debt. Therefore, to make paying off that debt easier in the future, the central banks aggressively drive down interest rates. While this temporarily eases the pressure on policy makers, it would result in a long term trend of debasing the dollar, that would end in the destruction of the US economy as we know it.

“That could still happen, of course. But what is actually happening in 2014 is the opposite. The dollar is on an absolute tear, rising sharply over the last few months against other major currencies. And American policy makers seem largely comfortable with the shift…in advance of annual meetings of the International Monetary Fund and World Bank this week, Treasury Secretary Jack Lew repeated language, used by every person to hold that job in modern times, that he favors a strong dollar.”

In this recent article for The New York Times, Neil Irwin explains why economic fundamentals are the real reason for the dollars rise. Of course, central bank policies do have an impact on the dollar, but as we have seen this year, the horse driving the change is the US economy, the Federal Reserve is just the cart that horse is pulling.

Image source: The New York Times

 

So, while the Fed has been aggressively buying bonds, expanding the monetary supply, and lowering interest rates–all of which should be lowering the value of the dollar–the opposite has been happening. And the reason for this is that growth in the U.S. is looking better, whereas overseas it is largely flat or reversing.

“The I.M.F. revised its World Economic Outlook on Tuesday, and compared with its forecasts from July, it now expects 2014 economic growth to be 0.5 percentage points stronger in the United States and 0.3 percentage points weaker in the countries using the euro (with particularly weak projections in the core of Europe, namely Germany, France and Italy).”

Image source: The New York Times

 

Now the Federal Reserve has wound down its QE program(s) while the ECB and others double down. These actions are in response the higher or lower growth prospects, with the Eurozone and Japan trying to stimulate growth and stave off deflation. So the changes in the respective currencies are driven by the economic changes first, with the central banks then reacting accordingly.

While the stronger dollar has a mixed effect on U.S. prospects — it depends on if you are importing or exporting — Americans are mostly taking the change in stride as long as it’s accompanied by stronger growth here at home.

Read the rest of Mr. Irwin’s piece here.