Solved: Drivers of the dollar cycle

With implications for the dollar, global economy, interest rates, asset prices, and asset allocation

Since the start of floating exchange rates in 1973, the dollar has waxed and waned through three major cycles, swinging peak to trough and back again by as much as a third of its value.  These cycles represent most of the dollar’s overall volatility – with consequent implications for roughly half of global trade and the plurality of financial asset prices denominated in dollars – and have been blamed for some of the biggest macro events of the last five decades:  the Great Inflation and “petrodollar” crises of the ‘70s, stock market crashes in 1974 and 1987, Japan’s economic bubble and lost decade, the Latin American debt crises of the ‘80s, the Emerging Market crises of the late ‘90s, and massive swings in global commodity prices along the way.  Chinese policymakers have even attributed geopolitical turmoil to dollar cycles.¹  Yet, despite their centrality to the global political economy, the source of these cycles has remained one of international finance’s great mysteries.

Until now.

I solve the mystery by combining a fortuitous “natural experiment” with spectral analysis, a mathematical technique that allows one to analyze the volatility and comovement of economic variables at specific frequencies – like the 17-year periodicity of dollar cycles – rather than a (sometimes misleading) average of all frequencies that results from regression or correlation analysis.  The results make intuitive economic sense and have profound implications not only for the future path of the dollar, but for the economic outlook, interest rates and asset prices.  Indeed, reversing the analysis suggests that the dollar’s current strength tells us much about one of the dominant themes driving the global economy: Localization.  The resultant asset allocation implications are manifold.