John Connally, who ran the US Treasury under President Richard Nixon five decades ago, once opined to his international counterparts that “the dollar is our currency, but it’s your problem.” This year it’s been a bigger headache than usual. The mighty greenback surged against just about every other currency, driven by a combination of higher US interest rates, diverging economic prospects and a hunt by investors for safety. For some countries, that has meant the potential for faster inflation — exacerbating a problem already plaguing much of the world — and a greater risk of tipping into recession. Others have felt the pain through higher costs for vital imports or an increased repayment burden for dollar-denominated debt.
1. How strong has the dollar gotten?
Stronger than at any time since the 1980s, according to an index from the US Federal Reserve that uses a basket of currencies and adjusts for differences in inflation. By that measure, the US currency climbed more than 10% in the first 10 months of 2022, eclipsing even the highs seen during the Covid-related financial panic of 2020. Against the yen, the dollar hit a mark last seen in 1990 — around the beginning of Japan’s so-called lost decade — and against the euro it strengthened to better than 1-to-1 for the first time since 2002, when the common currency was still in its infancy. Relative to China’s currency, the greenback was at its most formidable level since the 2008 financial crisis.
2. What caused the surge?
A combination of more alluring interest rates in the US and a feeling for many that their money is safer in dollar-denominated assets during troubling times — what with war in Ukraine, slowing global economic growth and other woes. That played out in several ways:
• The hike in global interest rates was driven in large part by the Fed, which, like many of its counterparts, has used supersize increases to try to rein in rapid inflation. (The idea is that higher borrowing costs will weigh on investment and spending, slowing growth and also, hopefully, reining in the pace at which consumer prices increase.)
• The US central bank was in the vanguard of tightening in 2022, especially in comparison with the euro area, where a more precarious growth outlook meant policymakers were much slower to get going. The difference was even more pronounced versus Japan. There, officials have been more inclined to stick with ultralow borrowing costs because of the country’s unique history with deflation — a drop in prices that risks bringing economic activity to a screeching halt.
• Higher US rates make it more expensive to borrow money to invest, hurting the outlook for riskier assets like stocks, or the bonds and currencies of countries with weaker economies. Those markets also tend to suffer when global growth is under pressure or geopolitical concerns are elevated — both prominent factors in 2022. Under these conditions investors often flock toward so-called havens. As the world’s leading reserve currency, the dollar tends to be a beneficiary of such flows, adding further impetus for it to appreciate.
3. What problems does this create for other countries?
In more normal times, policymakers might welcome a weakening of their currencies, which tends to stimulate growth by making exports more competitive, while encouraging consumers and businesses to buy local. But times haven’t been normal.
• The main problem that’s been bedeviling finance officials from Frankfurt to Seoul for the past year has been inflation. Weak currencies add fuel to that by increasing the cost of imported products such as fuel and food. They also improve the competitiveness of domestic industry on the global stage. That’s good insofar as it encourages activity, but it also stimulates inflation. The constant battering from a weak currency thus risks creating financial instability, draining valuable foreign-exchange reserves and steering officials toward policies that will ultimately crimp the economy’s prospects.
• A strong greenback can also cause problems for countries — and companies — that borrow in dollars, because it increases their debt burden in local currency terms. This is a concern for many emerging markets in particular. They tend to lean more on so-called hard currencies like the dollar than on smaller domestic debt markets, and they are more vulnerable to shifts in global sentiment.
• Nations that have chosen to peg the value of their own currency to the dollar — for example, Saudi Arabia and others in the Persian Gulf region — face challenges both in maintaining that link and in dealing with the economic fallout of basically importing the dollar’s strength, which distorts policy and prices domestically.
4. What have others done about it?
With the risk of economic damage spreading, the Japanese central bank intervened directly to prop up the yen for the first time since 1998. Officials from New Delhi to Santiago took similar steps. Meanwhile, China — which controls its exchange rate to a certain extent by setting a band within which it is allowed to float — has at times used its official reference rates (so-called daily fixings) to try to mitigate market moves. The dollar’s strength has also forced some central banks to set interest rates higher than they might otherwise to maintain relative attractiveness for international investors and prevent currency values from sliding. The downside is that such a level of borrowing costs might be less than ideal for the domestic situation they’re trying to manage.
5. Is there some kind of global solution?
The pain that the dollar inflicted has echoes of the mid-1980s, when exchange-rate chaos forced the world’s most important finance officials to join hands and impose a solution to weaken the dollar — an agreement known as the Plaza Accord after the New York hotel where it was sealed. One key difference: The 1985 agreement involving the UK, France, West Germany, Japan and the US came only after the Fed’s then-boss, Paul Volcker, had already broken the back of inflation at home. That hasn’t been the case so far this year and, as a result, there hasn’t been such coordination, making it largely every country for itself.
6. What’s the view from the US?
US Treasury Secretary Janet Yellen said she believed financial markets were working as they should. The Fed, meanwhile, has been focused on fighting inflation. From its perspective, a strong dollar actually helps. By crimping the competitiveness of American exports (which are more expensive in foreign-currency terms), it acts to curb US economic growth, removing some inflationary pressure. It also makes imports relatively cheaper. US policymakers were therefore comfortable with the most aggressive interest-rate increases since Volcker’s battle in the 1980s. But they have been cognizant of the risk of global problems reverberating back on the US and undercutting what they’re trying to achieve. The US is a relatively contained economy, but it’s unlikely to be immune from a major global economic or financial market shock. There’ve been, of course, some signs of pain this year for riskier assets — that’s common when interest rates rise. But on a systemic level, institutions still appear to be functioning fairly normally and there are few signs of global markets breaking down as in previous crises.
7. What might pull the dollar back down?
An alleviation of inflationary pressures in the US that leads to lower expectations for Fed interest-rate increases could weaken the dollar, whether that easing comes in the measured fashion that the Fed is trying to achieve or as a result of a broader global shock. The Bloomberg Dollar Spot Index, which measures the greenback versus a basket of developed and emerging-market peers, in November witnessed its biggest one-day drop in more than a decade following cooler-than-expected consumer price index data. On the other hand, while a global slump that reverberates back upon America might weigh on the dollar, it’s also possible that an improvement of the situation outside the US could be a catalyst. The euro and other currencies have been weighed down this year in large part by the energy shock that followed Russia’s invasion of Ukraine, which has forced some countries to spend more on imported fuel and crimped economic growth. Improvements on that front could alleviate pressure on those currencies, which equates to a weakening on the dollar side of the ledger. There will also, of course, come a time when US interest-rate hikes begin to put the brakes on American economic growth, but how soon that happens and by how much are among the great unknowns.
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