Disastrous public finances, a relentlessly accelerating inflation, the sinking consumer confidence and a presidency struggling with falling approval ratings are all the U.S. media headlines.

That the dollar is not getting a cheer is perhaps normal, because even well-informed and sophisticated New Yorkers would be hard put to tell you what the greenback was doing against the euro – its main competitor in world finance.

The question would probably get more exciting if it were rephrased to focus on dollar-denominated assets, such as stock prices – a forward-looking indicator of “collective wisdom” that would tell the gloom-peddling media “what are you talking about?”

Indeed, the S&P 500 returned 31% over the last twelve months to those who took a bet on America. Europe’s blue chips trailed way behind with 22.7% (Euro Stoxx 50 in dollar terms), reminding the German-French wannabes about who runs the show in global finance.

Even gold – the doomsayers’ asset of choice – bit the Big Board’s dust with a negative return.

Surprisingly, America’s soaring public debt also found eager buyers on world markets. In the year to August, the non-residents’ holdings of Treasury’s bills, bonds and notes increased 7.2%, with more than half of those funds stashed into foreign governments’ assets.    

The world wants more dollars

And there is also an interesting message the greenback is sending to the U.S. monetary policy. Against all the prevailing gloom and doom, the dollar’s trade-weighted exchange rate rose nearly 3 percent over the last twelve months, increasing 4.3% and 9% against the euro and the Japanese yen respectively.

In a market governed by forces of demand and supply, those exchange rate movements tell us that an excess demand for dollar assets is pushing up the price of the dollar.

Incredibly for most people -- in spite of those huge increases in the supply of dollars by the U.S. Federal Reserve, the greenback is still appreciating in terms of world’s major currencies.

The policy message here is clear cut: An appreciating exchange rate calls for an increasing money supply, because an unchanged, or tightening, monetary policy would continue to drive up the relative price of the currency.

The U.S. monetary authorities will ignore that message. More than a decade of huge monetary easing and an explosion of public spending have created strongly rising costs and prices in labor and product markets. With fiscal policy literally locked up in an expansionary stance, the monetary policy must now be gradually tightened to moderate price inflation, with the help of an appreciating dollar exchange rate.

How much can a stronger dollar help?

With the external sector of the U.S. economy accounting for only 29% of the GDP, a large appreciation of the exchange rate would be needed to produce a significant and sustained decline in cost and price pressures that would affect the economy’s general inflation outlook.

Hold on to the dollar-based world economy

Apart from that, energy and labor costs are the two major sources of U.S. inflation pressures. Energy supplies are controlled by an international cartel, and the labor supply is America’s major structural problem with no solution over the near term.

At the moment, about 40% of the U.S. civilian population is out of the labor markets for lack of education and vocational training.

All that means that the task of the monetary policy will be quite difficult. Congressional elections in November of next year, followed by the election campaign for the presidential contest in November 2024 will most probably steer the Fed’s policy toward a gradual tightening of credit conditions to avoid a major growth recession and rising unemployment.

On current evidence and past experience, that’s a non-starter. A monetary gradualism and a willingness to tolerate rising inflation has always led to deep and protracted recessions.

This time won’t be different.

And that’s the story the dollar has yet to tell.  The unfolding U.S. growth recession will hit hard highly open and export-dependent European and Japanese economies. They stand to lose a good deal of their current $800 billion exports on U.S. markets that are underpinning their economic growth and employment creation.

China will also be hit hard on its $500 billion of U.S. exports. But the Chinese exporters could fare better than their European and Japanese competitors because they supply goods with stable demand and few, if any, local substitutes.

In such an environment, there won’t be many appealing choices to diversify out of the global dollar holdings into the euro or yen assets. The availability of Chinese investment outlets will also remain limited due to relatively small and tightly regulated financial markets.

The dollar, therefore, will remain the linchpin of the world financial system, but how long that will last will depend on U.S. fiscal policies.

The current practice where the Congress and the White House run up huge spending bills which the Fed either has to monetize – or refuse to monetize and create a recession – must stop.

If the U.S. wants to hold on to the privilege of managing the dollar-based global economy, it has to offer a currency of stable purchasing power.