Five ways a strong US dollar could hurt the global economy :: InvestMacro

by Alexandre TziamalesAnd the Sheffield Hallam University And the Yuan WangAnd the Sheffield Hallam University

– The US dollar was in A significant increase Against the major global currencies last year, it recently reached levels not seen in 20 years. It rose 15% against the pound, 16% against the euro, and 23% against the Japanese yen.

The dollar is the world’s reserve currency, which means that it is used in most international transactions. As a result, changes in its value have implications for the entire global economy. Here are five of the most important ones.

Dollar strength 1977-2022

The US Dollar Index or DXY is the US dollar that is measured against a basket of world currencies.
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1. More inflation

Gasoline and most commodities such as metals or timber are usually traded in US dollars (although with exceptions). So as the dollar gets stronger, these items cost more in the local currency. For example, in sterling, the cost of $100 of petrol has increased over the past year from £72 to £84. Since the price of a liter of gasoline in American dollar It also rose sharply, creating a double whammy.

When the cost of energy and raw materials is more expensive, the prices of many products for consumers and businesses rise, causing inflation worldwide. The only exception is the United States, where a strong dollar makes importing consumer products cheaper and thus can help tame inflation.

2. Threatened low-income countries

Most developing countries owe their debt in US dollars, so many of them owe much more than they did a year ago. As a result, many will struggle to find an increasing amount of local currency to service their debt.

We are already seeing this in Sri Lankaand other countries may be soon follow. They will either have to tax their economies more, issue inflationary domestic money or simply borrow more. The results could be a deep recession, hyperinflation, a sovereign debt crisis, or all three, depending on the path chosen. Developing countries caught in sovereign debt crises It can take years Or even decades of recovery, causing great suffering to their people.

3. A bigger US trade deficit

Other countries will buy fewer US products due to the strength of the dollar.
The US trade deficit, which is the difference between the amount of exports and imports, is already close to mammoth trillion dollars every year. President Joe Biden And the Donald Trump Before him he vowed to reduce it, especially against China. Some economists are worried The trade deficit increases US borrowing and reflects the fact that many manufacturing jobs have moved abroad.

US trade deficit as a percentage of GDP

Chart showing the US trade deficit as a percentage of GDP
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4. De-globalization from getting worse

The most obvious economic policy to prevent the growth of the trade deficit is the old game of imposing tariffs, quotas, or other barriers on imports. other countries tend to take revenge Against such protectionism, add their own taxes and other barriers to American products. In an era when Deglobalization has already begun Thanks to deteriorating Western relations with Russia and China, a stronger dollar is adding to the political impetus for protectionism and threatening global trade.

5. Eurozone Concerns

Weaker member states of the European Union such as Portugal and Ireland Greece Cyprus has become somewhat less vulnerable to investors who have raised borrowing costs to crisis levels than it was during the darkest days of the eurozone crisis. This is because a lot of their national debt Now at hand From the European Stability Mechanism (ESM), which was set up to help bail them out, as well as the friendliest investment banks within the eurozone.

However, the dollar is stronger pressure creation For the European Central Bank to raise interest rates to support the euro and reduce the cost of imports, including energy. This will put more pressure on Eurozone countries with high levels of debt. Italy, which is the ninth largest economy in the world and has a huge government debt of 150% of GDP, will be especially difficult To save the situation if it gets out of hand.

Putting these five points together, the dollar is very strong Yet another reason For fear of a global recession in the coming period. High inflation erodes consumer income and reduces consumption. Protectionism can reduce international trade and investment. Sovereign debt crises mean serious problems for many developing countries and perhaps even the eurozone.

Will the dollar continue to rise?

The dollar rose for economic and geopolitical reasons. The central bank of the United States – the Federal Reserve – raised interest rates significantly and also reversed its policy of creating money by Quantitative Easing (QE). This is with the aim of curbing inflation caused by COVID supply issues and the war in Ukraine as well as quantitative easing.

The stronger US dollar is a side effect of these higher interest rates. Since the dollar now offers a higher return when deposited in a US bank, it encourages foreign investors to sell their local currency and buy US dollars.

Of course, central banks in other jurisdictions like the UK have also been raising interest rates, and the Eurozone plans to do the same. But they are not acting as aggressively as the United States. Meanwhile, Japan is not tightening the screws at all, so the net result is still increased external demand for the greenback.

Another reason for the rise of the US dollar is that it is a classic safe haven when the world is worried about a recession – and arguably the current geopolitical situation makes it more attractive. The euro has suffered from the EU’s proximity to the war in Ukraine, its exposure to Russian energy and the odds of this happening Another crisis in the eurozone. It’s close to dollar parity for the first time in its early years.

The British pound has been hit by Brexit and also faces the prospect of a second referendum on Scottish independence and Possible trade war With the European Union on the Northern Ireland Protocol. Finally, the yen belongs to an economy that appears to be slowly losing steam. Japan is getting old and so is it Still uncomfortable With paging to enhance its production capabilities. A weak yen is also the price Japan pays to continue quantitative easing to keep interest rates low on its government debt.

It is difficult to predict the future direction of the US dollar when there are so many moving parts in the global economy. But we suspect that persistent inflation will force US interest rates to continue rising, and that combined with geopolitical shocks from the war and sovereign debt defaults, it will likely keep the dollar elevated. A strong US dollar is a response to trying times.Conversation

About the author:

Alexandre TziamalesSenior Lecturer in Economics, Sheffield Hallam University And the Yuan WangSeinor, Lecturer in Economics, Sheffield Hallam University

This article has been republished from Conversation Under a Creative Commons License. Read the original article.

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