The market is fiercely debating how much the dollar should depreciate. Here are three "key assumptions."

In the first five months of this year, the US dollar has fallen by 8.4%, marking the worst "start of the year" performance ever against a basket of global currencies. How will the dollar move forward? Renowned economist Robin Brooks has provided a detailed analysis of the three hypotheses currently being fiercely debated in the market.

In an analysis article titled "The Battle of Wills Surrounding the Dollar" published on the 6th and 10th, Robin Brooks, former chief economist of the Institute of International Finance and currently a senior fellow at the Brookings Institution, believes that the intense debate regarding the dollar's continued weakness is not a baseless argument but revolves around three core "hypotheses":

The first is the mildest, suggesting that this is just a temporary cyclical adjustment; the second is more concerning, fearing that the independence of the Federal Reserve may be undermined; and the third is the most extreme, believing that the dollar's status as a global reserve currency will be lost.

Brooks believes that the current debate about the direction of the dollar mainly focuses on two hypotheses, predicting that the dollar is still in a multi-cycle strengthening process that could last for decades.

The Real Extent of the Dollar's Decline: Data Over Panic

Many concerns about the recent movements of the dollar may have been exaggerated. He argues that "for the first time in years, the dollar is experiencing a sustained decline," and this unusual phenomenon has triggered various over-interpretations and exaggerated analyses.

Brooks clarifies the reality with specific data: since the election on November 5, the dollar has only fallen by 4% against other developed economies' currencies, while remaining basically flat against a basket of emerging market currencies.

Brooks warns, "No matter what headlines you read, the dollar has not experienced a collapse." From a broader perspective, the dollar remains relatively stable and continues to perform exceptionally strong over a longer time span.

However, despite the data showing a moderate decline in the dollar, discussions about its future direction have reached an unprecedented level of intensity. Brooks states that the intensity of this debate is something he "has not seen in years."

Hypothesis One: Healthy Adjustment or Cyclical Retreat?

The first viewpoint is relatively mild, suggesting that the dollar's decline is merely a short-term cyclical adjustment. This perspective views the current weakness of the dollar as a normal correction following the influx of funds due to America's "exceptionalism," which is a common ebb and flow phenomenon in the global currency market. Proponents of this view believe that this adjustment is healthy and will not pose a threat to the dollar's long-term status.

The article points out that in recent years, the US economy has outperformed others, growing far beyond other developed economies, acting like a huge magnet attracting global capital into the US, thereby pushing up the dollar. Now, as other economies like Europe and Japan begin to recover, the US's "exceptional" situation has changed, and capital will naturally seek to rebalance, leading to some funds flowing out of the US and causing a dollar correction. They believe this is entirely a normal economic cycle phenomenon and does not warrant alarm

Hypothesis 2: The Fed's "Pivot" and Deeper Unrest

The second viewpoint is more pessimistic, fearing that deeper structural changes are occurring. Brooks explains that around the time of the 2008 financial crisis, whenever U.S. economic data performed strongly, the dollar would actually decline, which is in stark contrast to the recent situation of "strong data = strong dollar."

Brook believes this phenomenon reflects market concerns about the Fed's policy stance, suggesting that the Fed may be more dovish than other central banks, maintaining low interest rate policies even in the face of strong economic data. Nowadays, this "strong data = weak dollar" correlation seems to be re-emerging. This reflects a deep-seated market anxiety regarding "concerns over the loss of the Fed's independence."

As many economists, including Nobel laureate Paul Krugman, have pointed out, the independence of central banks is the cornerstone of their credibility. Once the market doubts that monetary policy will be overly influenced by politics, the stability of the currency faces fundamental challenges.

Many analysts on Wall Street have expressed similar concerns. Strategists at JP Morgan have previously warned that political interference in monetary policy could become an important factor affecting the long-term trend of the dollar.

Hypothesis 3: Alarmist? The End of the Dollar's Reserve Status

The third hypothesis is the most extreme, suggesting that the recent policy chaos in Washington will lead to the dollar losing its status as a reserve currency. Brooks strongly questions this, arguing that this viewpoint is the least popular because the consequences it implies are catastrophic.

"If the dollar is no longer the world's core currency, the U.S. will no longer be able to easily finance itself through the issuance of government bonds, interest rates will soar, severely stifling economic growth and forcing the government into painful fiscal tightening."

So, is the dollar's status as a reserve currency really in jeopardy? Brooks directly answers in the negative. He believes that this possibility is " extremely unlikely." He emphasizes that the dollar's reserve currency status has been "established over the past few decades" and cannot collapse due to a few months of chaos.

More importantly, there is a clear "TINA" effect in the market, which stands for "There Is No Alternative." Neither the euro, yen, nor renminbi can currently fully replace the dollar in terms of scale, liquidity, and stability.

Overreaction of Market Sentiment

After analyzing the three hypotheses, Brooks provides his judgment. He believes that the current debate mainly oscillates between the first two hypotheses, meaning the market is grappling with whether the dollar's weakness is cyclical or reflects deeper structural issues.

Notably, Brooks observes that this debate has become "highly emotional," which itself is an important market signal. In his view, this precisely indicates that "the dollar is now oversold." The evolution of market fundamentals is always slow, while investor sentiment has clearly run ahead of reality.

In summary, Brooks believes that the current decline is merely an episode in a long-term upward trend. He summarizes with a weighty statement: “ The dollar is in a multi-decade appreciation cycle that is far from over. **”