Editor's note: Jimmy Zhu is the chief strategist at Fullerton Research. The article reflects the author's opinions and not necessarily the views of CGTN.

The huge swing in the value of the U.S. dollar since the start of 2022, driven by U.S Federal Reserve rate hikes and high inflation, coupled with the recent banking crisis in the United States, means that many countries should start diversifying their foreign exchange portfolios. And more companies should also reduce their reliance on the dollar when conducting international trade and raising funds.

One of the main factors driving the dollar higher in 2022 was accelerating inflation in the United States. While inflation has slowed over the past few months, it is still significantly above the Fed's 2 percent target. As long as defending price stability remains the Fed's main objective, it is unlikely to deliver the rate cuts that some investors now expect in the foreseeable future.

That said, it is essential for investors and policymakers to recognize the fact that the possibility of a resurgence in the value of the dollar cannot be discounted. As long as Fed officials reiterate the need to tame inflation, the dollar could rally quickly as some traders may unwind earlier bets that the central bank will cut rates.

Some previous crises triggered by rapid dollar appreciation, such as the 1997 Asian financial crisis and the Turkish lira devaluation in 2018, served as a crucial warning to global policymakers of the need to reduce the correlation of their own currencies with the dollar.

Most emerging market currencies use a managed float system where the exchange rate is determined by market forces, but the central bank can intervene to influence the exchange rate in extreme cases. However, the People's Bank of China (PBOC) and Monetary Authority of Singapore (MAS) employ a different strategy to maintain exchange rate stability.

The Chinese yuan and Singapore dollar track a trade-weighted basket of currencies, and data shows that linking the exchange rate to a basket of currencies effectively reduces the impact of U.S. dollar fluctuations.

For example, the negative correlation between the U.S. dollar index and the Chinese yuan is 0.53 over the past five years, while the corresponding figure for the Singapore dollar is 0.58. Both figures are significantly lower than the negative correlation between the U.S. dollar index and the emerging market currency index, which stands at 0.71 over the same period. Correlation is a statistical measure of the relationship between bivariate data.

Because of the dollar's strong position in international trade and its impact on commodity prices, policymakers around the globe may need to temper its influence. Fluctuations in the value of the dollar can have serious consequences for many countries, regardless of the direction of the movement.

When the dollar rose rapidly, countries with dollar-denominated debts faced an increased burden as repayments on those debts increased. Increasing burdens raise the risk of default and can lead to financial instability. When the dollar depreciates, companies that export to the United States can face disadvantages as their products become more expensive and less competitive.

On the other hand, simply pegging a currency to a basket of currencies is not sufficient to reduce foreign exchange volatility, as many currencies are heavily influenced by the movements of the U.S. dollar as it is one of the most widely traded currencies. Policymakers could consider diversifying their foreign exchange reserve holdings as a strategy to mitigate U.S. dollar risks.

In addition, policymakers may also encourage more international trade to be conducted through currencies other than the U.S. dollar, which could help reduce the dominance of the U.S. dollar in global trade and finance.

The collapse of Silicon Valley Bank is a warning that the dollar's safe-haven status is weakening

Since Silicon Valley Bank (SVB) collapsed in early March, and was followed by a series of banking crises in the United States, the price of gold has rallied more than 10 percent and now stands above $2,000 per ounce for the first time since March 2022.

The overwhelming demand for gold not only illustrates the flight to safe-haven assets, but also reflects the falling confidence in the U.S. dollar. The dollar tends to rise in any financial or economic crisis because of its safe-haven status, but the dollar index has fallen about 4 percent since the collapse of SVB.

If U.S. savers continue to move cash elsewhere, such as into gold or money market funds, some banks will run out of liquidity and it could even trigger a credit crunch. When banks run out of money to lend because lenders do not have enough cash available for consumers and businesses.

It looks as if the U.S. banking crisis has already had some effect on business. Manufacturing activity slumped in March. The Institute for Supply Management (ISM) manufacturing PMI fell to 46.3 in March 2023, the lowest level since May 2020. The University of Michigan's gauge of U.S. consumer sentiment was revised lower to 62 in March from a preliminary reading of 67.

A slowdown in U.S. economic activity would be another potential threat to trigger a credit crunch at a later date, as slower growth could cause a growing number of U.S. companies to struggle to repay loans since revenues and cash flows have fallen. Such an outcome would lead to more bad loans in the banking system, increasing the risk of a credit crunch.

The yield spread between 2-year and 10-year U.S. government bonds has been inverting since early 2022, a reliable indicator of an impending U.S. recession. This is another risk that threatens U.S. financial stability, encouraging more capital flight from the U.S. financial system, and such an outcome would establish a weaker dollar profile.

That said, countries with relatively high dollar exposure should start strategizing to diversify their foreign exchange portfolios into other major reserve currencies, such as the euro, yen and Chinese yuan. By doing so, it can reduce the risk of a sudden sharp move in the U.S. dollar and limit the impact on its domestic financial position.