Common mistakes about the dollar and currencies

The common belief: A rising dollar reflects the strength of the US economy and carries no real cost for the rest of the world.

What the data shows: A strong dollar tightens financial conditions globally, because so much debt and trade is denominated in it. As the DXY rose from around 80 in mid-2014 to roughly 100 by early 2015 amid Fed-ECB divergence, commodities and emerging-market assets fell sharply; in September 2022 it reached about 114, a two-decade high, during aggressive Fed hiking, straining dollar borrowers outside the US (ICE). The dollar is less a thermometer of US strength than the tap controlling global liquidity: when it rises, it tightens everywhere at once.

→ In-depth explanation: Why does a strong dollar coincide with global crises?

The common belief: De-dollarisation is happening fast, and the dollar’s role as the world’s reserve currency is collapsing.

What the data shows: The dollar held roughly 57% of allocated FX reserves in Q3 2025, down from about 71% at the start of 1999 (IMF COFER) — a real but slow decline. Almost all of the Q2 2025 drop, from 57.79% to 56.32%, reflected exchange-rate effects as non-dollar currencies appreciated, not active selling by central banks. Adjusted for constant exchange rates, the share barely moved.

→ The full explanation: What makes the dollar the global reserve currency?

The common belief: Devaluing a currency immediately and mechanically improves a country’s trade balance.

What the data shows: The response typically follows a J-curve: in the short run the balance often deteriorates, as import prices rise before export volumes adjust. The eventual effect depends on trade elasticities and on how much pricing is set in dollars rather than local currency, which mutes the textbook pass-through.

→ Full breakdown: How do exchange rates affect trade balances?

The common belief: Currencies converge to their purchasing-power-parity value, so an "overvalued" currency (per the Big Mac index) will correct.

What the data shows: PPP holds reasonably over multi-decade horizons but fails consistently over the short and medium term. Deviations can persist for years, and the framework explains little about moves on horizons shorter than roughly three to five years. It is a long-run anchor, not a timing tool.

→ Fuller explanation: What is purchasing power parity and why does it fail short-term?

The common belief: When an emerging-market currency collapses, the cause is essentially domestic policy failure.

What the data shows: The trigger is frequently external: the dollar cycle and dollar-denominated debt, the so-called "original sin." When the dollar appreciates and US rates rise, the cost of servicing dollar debt climbs independently of a country’s own policies, so crises tend to cluster during dollar-strength episodes.

→ Extended explanation: Why do emerging markets face currency crises?

The common belief: Borrowing in a low-rate currency to invest in a higher-rate one is close to guaranteed income while the rate gap holds.

What the data shows: The payoff is asymmetric — small steady gains punctuated by rare, violent losses. See the equity-volatility dataset for the construction and sources. On 31 July 2024 the Bank of Japan raised its policy rate to around 0.25%; the unwinding of yen-funded positions helped drive the Nikkei 225 down about 12% on 5 August, its worst session since 1987, while the VIX briefly rose above 60 (BoJ; Reuters). Carry returns resemble selling insurance, not collecting rent.

→ The complete explanation: What is carry trade and why is it dangerous?

The common belief: The dollar index (DXY) captures the dollar’s strength against the global economy.

What the data shows: The DXY is about 57.6% an inverse euro proxy, on a basket of six currencies whose weights have been essentially fixed since 1973 (ICE). It excludes the Chinese yuan, Mexican peso, Korean won and Australian dollar — several of today’s largest US trading partners. A rising DXY reports the dollar against a 1973 trade map, not against the world.

→ Full account: How does the dollar index (DXY) work?

The common belief: The euro-dollar rate is one currency pair with no special importance.

What the data shows: EUR/USD is the most traded pair in the world, and the dollar sits on one side of about 88% of all FX transactions (BIS, April 2022). The empirical detail appears in how to read the EUR/USD pair. Because the euro carries 57.6% of the DXY, EUR/USD also drives most of the headline dollar index — the reference rate the rest of the market reads first.

→ Complete breakdown: Why is the euro-dollar rate watched globally?

The common belief: The yen rallies in crises because Japan’s economy is fundamentally safe.

What the data shows: The yen’s haven behaviour stems mainly from its role as a funding currency. In stress, yen-funded carry positions unwind, forcing yen purchases that push the currency up — a mechanical flow effect rather than a verdict on Japanese fundamentals. August 2024 illustrated this: the yen surged on a global deleveraging scramble, not on good domestic news.

→ Complete explanation: What causes the Japanese yen to act as a safe haven?

The common belief: If dollars become scarce, that is a US issue with little relevance abroad.

What the data shows: The global system runs on dollar liabilities held outside the United States — offshore dollar debt through FX swaps and forwards reached around $26 trillion by mid-2022 (BIS). In March 2020 the cross-currency basis widened sharply (about 49 basis points at three months in early March, ECB) and the Fed deployed swap lines with five major central banks on 15 March, then nine more on 19 March; total take-up reached roughly $439 billion by end-March (BIS). Related Q&A: our breakdown of central-bank swap lines.

→ Detailed explanation: How does dollar funding stress manifest in global markets?

The common belief: The dollar can remain the world’s reserve currency forever without any structural strain.

What the data shows: The Triffin dilemma describes the tension: supplying the dollar liquidity the world needs requires the US to run persistent external deficits, which can eventually erode confidence in the dollar’s value. The reserve role and domestic stability pull in opposite directions, so the question is not whether tension exists but how it is managed.

→ In-depth explanation: What is the Triffin dilemma?