The rise of the greenback looks like
something to welcome. That is to ignore the central role the dollar plays in
global finance
THE world’s most important currency is flexing its
muscles. In the three weeks following Donald Trump’s victory in America’s
presidential elections, the dollar had one of its sharpest rises ever against a
basket of rich-country peers. It is now 40% above its lows in 2011. It has
strengthened relative to emerging-market currencies, too. The yuan has fallen
to its lowest level against the dollar since 2008; anxious Chinese officials
are said to be pondering tighter restrictions on foreign takeovers by domestic
firms to stem the downward pressure. India, which has troubles of its own
making (see article), has seen its currency reach an all-time low against
the greenback. Other Asian currencies have plunged to depths not seen since the
financial crisis of 1997-98.
The
dollar has been gradually gaining strength for years. But the prompt for this
latest surge is the prospect of a shift in the economic-policy mix in America.
The weight of investors’ money has bet that Mr Trump will cut taxes and spend
more public funds on fixing America’s crumbling infrastructure. A big fiscal
boost would lead the Federal Reserve to raise interest rates at a faster rate
to check inflation. America’s ten-year bond yield has risen to 2.3%, from
almost 1.7% on election night. Higher yields are a magnet for capital flows
(see article).
Zippier
growth in the world’s largest economy sounds like something to welcome. A
widely cited precedent is Ronald Reagan’s first term as president, a time of
widening budget deficits and high interest rates, during which the dollar
surged. That episode caused trouble abroad and this time could be more
complicated still. Although America’s economy makes up a smaller share of the
world economy, global financial and credit markets have exploded in size. The
greenback has become more pivotal. That makes a stronger dollar more dangerous
for the world and for America.
Novus
ordo seclorum
America’s
relative clout as a trading power has been in steady decline: the number of
countries for which it is the biggest export market dropped from 44 in 1994 to
32 two decades later. But the dollar’s supremacy as a means of exchange and a
store of value remains unchallenged. Some aspects of the greenback’s power are
clear to see. By one estimate in 2014 a de facto dollar zone, comprising
America and countries whose currencies move in line with the greenback,
encompassed perhaps 60% of the world’s population and 60% of its GDP.
Other
elements are less visible. The amount of dollar financing that takes place
beyond America’s shores has surged in recent years. As emerging markets grow
richer and hungrier for finance, so does their demand for dollars. Since the
financial crisis, low interest rates in America have led pension funds to look
for decent yields elsewhere. They have rushed to buy dollar-denominated bonds
issued in unlikely places, such as Mozambique and Zambia, as well as those
issued by biggish emerging-market firms. These issuers were all too happy to
borrow in dollars at lower rates than prevailed at home. By last year this kind
of dollar debt amounted to almost $10trn, a third of it in emerging markets,
according to the Bank for International Settlements, a forum for central
bankers.
When
the dollar rises, so does the cost of servicing those debts. But the pain
caused by a stronger greenback stretches well beyond its direct effect on
dollar borrowers. That is because cheap offshore borrowing has in many cases
caused an increased supply of local credit. Capital inflows push up local asset
prices, encouraging further borrowing. Not every dollar borrowed by
emerging-market firms has been used to invest; some of the money ended up in
bank accounts (where it can be lent out again) or financed other firms.
A
strengthening dollar sends this cycle into reverse. As the greenback rises,
borrowers husband cash to service the increasing cost of their own debts. As
capital flows out, asset prices fall. The upshot is that credit conditions in
lots of places outside America are bound ever more tightly to the fortunes of
the dollar. It is no coincidence that some of the biggest losers against the
dollar recently have been currencies in countries, such as Brazil, Chile and
Turkey, with lots of dollar debts.
The eye
of providence
There
are lurking dangers in a stronger dollar for America, too. The trade deficit
will widen as a strong currency squeezes exports and sucks in imports. In the
Reagan era a soaring deficit stoked protectionism. This time America starts
with a big deficit and one that has already been politicised, not least by Mr
Trump, who sees it as evidence that the rules of international commerce are
rigged in other countries’ favour. A bigger deficit raises the chances that he
act on his threats to impose steep tariffs on imports from China and Mexico in
an attempt to bring trade into balance. If Mr Trump succumbs to his
protectionist instincts, the consequences would be disastrous for all.
Much
naturally depends on where the dollar goes from here. Many investors are
sanguine. The greenback is starting to look dear against its peers. The Fed has
a record of backing away from rate rises if there is trouble in emerging
markets. Yet currencies often move far away from fundamental values for long
periods. Nor is it obvious where investors fleeing America’s currency might run
to. The euro and the yuan, the two pretenders to the dollar’s crown, have
deep-seated problems of their own. The Fed, whose next rate-setting meeting
comes this month, may find it harder than before to avoid tightening in an
economy that is heating up.
If the
dollar stays strong, might protectionist pressure be defused by co-ordinated
international action? Nascent talk of a new pact to rival the Plaza Accord, an
agreement in 1985 between America, Japan, Britain, France and West Germany to
push the dollar down again, looks misplaced. Japan and Europe are battling low
inflation and are none too keen on stronger currencies, let alone on the
tighter monetary policies that would be needed to secure them (see article).
Stockmarkets
in America have rallied on the prospect of stronger growth. They are being too
cavalier. The global economy is weak and the dollar’s muscle will enfeeble it
further.
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