The Return of the USD Doom Loop

The European Energy Crunch Version

One of my first blog posts on Cheap Convexity, more than two years ago now, was on this idea of a US dollar “doom loop.” The idea broadly being that the US dollar is a determinant variable in the global manufacturing cycle and then acts as a relative cyclical force given the US economy’s divergent make up relative to most of the developed world. The combination of these two variables creates self fulfilling pro-cyclical force.

We know USD tends to do well in times of weaker global growth because the US is by far the least levered developed market economy to global trade. DM exports still account for +20% of GDP, in the US that number is closer to 12%.

The other angle is, the dollar itself can hurt global trade and output. This is Hyun Song Shin at the BIS and Gita Gopinath when she was at Harvard University. Gita takes the global invoicing angle and Hyun looks at it from a financing perspective. The focus of Hyun is, a broad appreciation of the dollar dampens international trade by weighing on the operation of credit intensive global value chains (GVCs).

The doom loop as I tried to outline in 2020 = Higher USD => lower global manufacturing => lower commodity prices => lower global trade => stronger dollar (less exposed to trade on relative basis) => lower global manufacturing. And the loop was in motion.

The question now is as the US dollar is making a 20y high, has the European energy crisis brought back the dollar doom loop of the 2010s?