Rising dollar creates problems for global economies

The US dollar is experiencing a one-of-a-kind rally. For the rest of the world, this is a big problem.

The role of the dollar as the main currency used in global trade and finance means that its fluctuations have widespread impacts. The currency’s strength is being felt in fuel and food shortages in Sri Lanka, record inflation in Europe, and Japan’s exploding trade deficit.

The surge threatens to exacerbate a slowdown in global growth and magnify inflation headaches for global central banks. Worryingly, attempts by policymakers in China, Japan and Europe to defend their currencies are largely failing in the face of the relentless rise in the dollar.

Last week, the dollar broke a key level against the Chinese yuan, with the dollar buying more than 7 yuan for the first time since 2020. Japanese officials, who had previously stood aside as the yen lost a fifth of its value this year, began to worry publicly that the markets were going too far.

The ICE U.S. dollar index, which measures the currency against a basket of its major trading partners, is up more than 14% in 2022, on track for its best year since the index launched in 1985. The euro, Japanese yen and British pound fell to multi-decade lows against the greenback. Emerging market currencies took a beating: the Egyptian pound fell 18%, the Hungarian forint 20% and the South African rand 9.4%.

The dollar’s rise this year is fueled by the Federal Reserve’s aggressive interest rate hikes, which have encouraged global investors to withdraw money from other markets to invest in higher-yielding US assets. Recent economic data suggests that US inflation remains stubbornly high, strengthening the case for further Fed rate hikes and an even stronger dollar.

The bleak economic outlook for the rest of the world is also boosting the greenback. Europe is on the front line of an economic war with Russia. China faces its biggest slowdown in years as a decades-long property boom unfolds.

Year-to-date performance against the US dollar

For the United States, a stronger dollar means cheaper imports, a tailwind for efforts to contain inflation, and record relative purchasing power for Americans. But the rest of the world is being strained by the rising dollar.

“I think it’s still early days,” said Raghuram Rajan, professor of finance at the University of Chicago Booth School of Business. When he was Governor of the Reserve Bank of India for the past decade, he complained loudly about how Fed policy and a strong dollar have hit the rest of the world. “We’re going to be in a high rate regime for a while. Weaknesses will accumulate.

On Thursday, the World Bank warned that the global economy was headed for recession and “a series of financial crises in emerging and developing economies that will cause them lasting harm”.

The stark message adds to concerns about worsening financial pressures in emerging markets outside of well-known weak links such as Sri Lanka and Pakistan which have already sought help from the International Monetary Fund. Serbia became the latest to open talks with the IMF last week.

“Many countries haven’t gone through a cycle of much higher interest rates since the 1990s. There’s a lot of debt there, increased by borrowing during the pandemic,” Mr Rajan said. Stress in emerging markets will worsen, he added. “It’s not going to be contained.”

A stronger dollar makes the debts that governments and companies in emerging markets have incurred in US dollars more expensive to repay. Emerging market governments have $83 billion in US dollar debt maturing by the end of next year, according to data from the Institute of International Finance which covers 32 countries.

“You have to see this through a fiscal lens,” said Daniel Munevar, an economist at the United Nations Conference on Trade and Development. “You enter 2022 and all of a sudden your currency goes down 30%. You will probably be forced to cut spending on health, education to meet these [debt] Payments.”

Cumulative changes in interest rates since January 2021

Brazil’s central bank begins to raise its

interest rate in March 2021

The rising currency has compounded the pain of smaller countries by making crucial imports of food and fuel priced in US dollars more expensive. Many have drawn on stocks of dollars and other foreign currencies to help finance imports and stabilize their currencies. And while commodity prices have retreated from their peaks of recent months, that has done little to ease the pressure on developing countries.

“If you get more dollar appreciation, that will be the straw that breaks the camel’s back,” said Gabriel Sterne, head of emerging markets research at Oxford Economics. “You already have frontier markets on the verge of tipping into crisis, the last thing they need is a strong dollar.”

Central banks in emerging markets have taken drastic measures to curb the depreciation of their currencies and bonds. Argentina raised interest rates to 75% on Thursday as it seeks to rein in spiraling inflation and defend the peso, which has lost nearly 30% against the dollar this year. Ghana also surprised investors last month by raising rates to 22%, but its currency continues to fall.

It’s not just developing economies that are struggling to cope with weaker currencies. In Europe, the weakness of the euro is amplifying a historic rise in inflation caused by the war in Ukraine and the resulting spike in gas and electricity prices.

At the European Central Bank’s meeting on September 8, President Christine Lagarde expressed concern about the euro’s 12% fall this year, saying it has “aggravated the build-up of inflationary pressures”. The ECB signals a more aggressive policy, with investors now expecting a rate hike to 2.5%. But that didn’t do much to help the value of the currency.

The euro is one of the currencies that has fallen to multi-decade lows against the dollar.

Photo:
Gregorio Borgia/Associated Press

The ECB is powerless against dollar strength, said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management. “Whether the ECB becomes more hawkish, whether there’s an improvement in the economic outlook, whatever happens, that’s usually offset by renewed dollar strength,” he said.

US Treasury Secretary Janet Yellen has acknowledged that dollar appreciation could pose problems for emerging economies, especially those with large dollar-denominated debts. But she said in July she was not worried about a self-perpetuating cycle that could slow global economic growth.

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The strength of the dollar has spilled over to Wall Street, weighing on the profits that American companies make abroad and limiting investments linked to commodities such as gold and oil.

“The strong dollar has created a headwind for almost every major asset class,” said Russ Koesterich, co-head of Global Asset Allocation at BlackRock..

“That’s another aspect of the tighter financial terms and it affects everything.”

Investors and economists are raising the prospect of global action to help weaken the dollar, though they warn the likelihood of such a move remains low. In 1985, the United States, France, West Germany, the United Kingdom and Japan launched a joint effort, known as the Plaza Accord, to lower the value of the dollar to amid concerns about the global economy.

“There might be some justification for a coordinated intervention to weaken the dollar,” said Paresh Upadhyaya, director of currency strategy at asset management firm Amundi US. “Outside the United States, a strong dollar is now becoming a huge headwind for central banks.”

China’s central bank tried to support the yuan by releasing more dollar liquidity into the market. It has reduced the amount of reserves banks must hold for their foreign currency deposits and has always set the daily rate – a benchmark for the currency – higher than market expectations.

The dollar is strengthening. Although it may seem like something to be happy about, a surge in the value of the dollar can affect the economy in unexpected ways. The WSJ’s Julia-Ambra Verlaine explains. Artwork: Jordan Kranse

Chinese regulators’ heightened sensitivity to the yuan’s decline may stem from their fears that a weak yuan has the power to further dampen consumer confidence, said Tommy Xie, head of research and strategy for Greater China at OCBC Bank.

“A depreciation of the yuan can create a vicious circle,” Mr. Xie said.

In Japan, policymakers fear that the fall of the yen to its lowest level in 24 years against the dollar could hurt businesses. Bank of Japan Governor Haruhiko Kuroda said this month that the sharp depreciation of the yen “is likely to make corporate business strategy unstable.”

The weak yen helped lead Japan to its biggest ever monthly trade deficit in August – 2.82 trillion yen, or about $20 billion – with the value of imports rising 50% due to the rise energy prices and the decline of the currency.

Prime Minister Fumio Kishida said on Wednesday that Japan needed to find ways to take advantage of the positive effects of the yen’s depreciation. One solution: invite more tourists.

“It is important to strengthen efforts to increase our country’s earning power,” he said.

—Julia-Ambra Verlaine contributed to this article.

Yen weakness helped lead Japan to its largest ever monthly trade deficit in August.

Photo:
News by Noriko Hayashi/Bloomberg

Write to Chelsey Dulaney at [email protected]Megumi Fujikawa at [email protected] and Rebecca Feng at [email protected]

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. rise dollar creates of problems for the economies world

. Rising dollar creates problems global economies

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