The value of the US dollar has risen during the Ukraine war. If peace breaks out, the dollar might be one of its casualties.
In the currency markets of today, there is a story of war and peace. It has one main plot and a lot of smaller ones. So far, there is no end to the story. That could happen sooner than many people now think.
The narrator of the story about neutral, Entente, and Central Power currencies during World War I had an easier job than the narrator of this story. (See Brendan Brown's 2011 book "Monetary Chaos in Europe," chapter 2.)
Today's Russia war, whether it's the military conflict in Ukraine or the economic war between the EU/US and Russia, is not so all-encompassing in terms of the world's economic and monetary affairs, but it is important. Today's money situation is much more complicated than it was during World War I, when most people thought that the end of the war would be the start of a journey in which key currencies would eventually return to their gold parities before the war.
During the 1914–18 war, any sudden news of a possible end to the war, like President Woodrow Wilson's peace notes in December 1916, would cause the neutral currencies (Swiss franc, Dutch guilder, Spanish peseta) to drop sharply, while the German mark and Austrian-Hungarian crown would go up a lot, and the British pound and French franc would go up less. In theory, a sudden emergence of peace diplomacy today would probably make the euro and the British pound go up and the Canadian dollar, US dollar, and Swiss franc go down.
When both sides are tired and the military is stuck, unexpected diplomatic moves to end the war can happen. The same things are happening now.
Much of Ukraine's infrastructure has been destroyed, and the country's government is printing money to pay its soldiers (see Kenneth Rogoff et al., "Macroeconomic Policies for Wartime Ukraine," Center for Economic and Policy Research, August 12, 2022). As opposed to military aid, general economic aid from the West is falling far short of what was promised. All of these pictures of Russian weapons depots on fire may or may not have gotten people interested in giving money, but they haven't led to any progress.
Moscow's propaganda says that the US and UK are willing to fight their proxy war against Russia until the last Ukrainian soldier dies. The death toll, which includes both soldiers and civilians, backs up this claim.
At the same time, the Washington Post has stories that seem to have been leaked about how President Volodymyr Zelensky betrayed the Ukrainian people by not telling them in late 2021 and early 2022 that the US government knew a Russian invasion was coming. From what I've heard, many Ukrainians are angry that their government didn't warn them and don't believe its shocking explanations (for example, to prevent a flight of capital out of the country).
Is all of this setting the stage for a possible power shift in Kiev that could lead to a diplomatic solution sooner rather than later? If so, President Joe Biden might be able to take credit for it before the midterm elections. This winter won't be as bad for Western Europe if the first ceasefire agreement includes a clause that Moscow won't shut off the gas pipelines.
The goal here isn't to guess how the war will end, but to describe a peace scenario that is likely to happen and show how currency markets would change as the likelihood of it happening grows.
The main thing that would affect currencies would be how the economic war between the EU/US and Russia played out. People in Western Europe would hope that a ceasefire would help a lot with the natural gas shortage.
Natural gas prices there would go down. In turn, that would boost the moods of consumers and business owners, who are down because they are worried about getting huge gas bills or even having to ration gas this winter. Massive programs that use money inflation to help people who can't afford fuel would stop in their tracks. As fears of a depression faded, the European Central Bank (ECB) could take firm steps to tighten the money supply.
We could easily imagine that if the peace scenario came to pass, the economies of Europe would bounce back from a winter slump in 2023. That would happen at the same time as the US economy went into a recession because of "Powell disinflation," which includes the continued bursting of bubbles in the tech space and residential construction, as well as a possible bust in the private equity market.
Even though a big rise in the euro is likely in a peace scenario, it is not a sure thing. Russia might wait to turn on the gas pipelines again until it knows for sure what will happen with the frozen deposits of its central bank in Western Europe. From the top of the Organization for Economic Cooperation and Development (OECD) to the bottom, there has been talk that a reparations commission would put these in a safe place.
More generally, it's possible that most European households aren't cutting back on spending as much as economists think they will. Many people may not have thought that the high prices for natural gas would last past this winter. Then, in effect, they had to pay more taxes, but only for a short time. Economic theory says that taxes like these, which are paid to North American natural gas producers in this case, have much less of an effect on spending than permanent taxes.
The euro still has a lot of problems. How can the ECB ever get monetary conditions back to normal when so much of the monetary base is backed by loans and credits to weak sovereigns and banks (see Brendan Brown, "ECB's Long Journey into Currency Collapse Just Got a Lot Shorter," Mises Wire, July 23, 2022)?
In theory, the US dollar and, even more so, the Canadian dollar would lose from peace what they have gained from war. Both have gotten fuel from the energy sector boom in their home country. Because of the economic war, neither country has lost real income as a whole. In fact, Canada's real income has gone up. The boom in the US defense industry has also been good for the dollar, and it should keep going even after the war ends.
Peace won't stop Europe from trying to get less of its energy from Russia and more from North American gas and renewable sources. But we can imagine that in the long run, Germany could have an advantage in renewable energy, and North America could lose potential sales outside of Europe to Russia because their gas is cheaper. Most people think that Russia will put an increased focus on building more LNG (liquid natural gas) terminals. These will let it send its natural gas to markets around the world.
In the end, peace is most likely bad for the US dollar. But this doesn't explain the big question of how and when US inflation will get worse again.
