Global Implications of the Strength of the U.S. Dollar
The U.S. dollar is the strongest it has been in two decades, but what does that mean in the larger domestic and global context? On the homefront it seems to be a positive trend, with American consumers now facing relatively lower prices as the Fed continues to battle inflation. However, the United States economy does not operate in a vacuum. The growing strength of the dollar is proving troublesome for economies around the world.
The interest rate hikes initiated by the Fed in order to fight inflation are the root cause of the dollar’s sudden surge. According to a New York Times article on the issue, the United States has managed to effectively export that inflation, causing higher prices in other countries and devaluing foreign currencies. Earlier this week the British pound reached a record low against the dollar, and everything from the euro to the yen to the dinar is following the same trend.
Source: The New York TImes
The reason that changes in the value of American currency have such outsized effects on the economy at large is because the U.S. dollar operates as the world’s reserve currency. The International Monetary Fund estimates that 40% of the world’s transactions—including those where the United States is not a party—are done in dollars. Especially in times of crisis, the dollar has traditionally served as a stabilizer, meaning that the pandemic, relentless climate disasters, and the war in Ukraine have all pushed foreign economies towards the greenback.
The negative effects of a strong dollar are being felt worldwide, but the issue is particularly alarming in developing countries, where increasing prices of food, fuel, and medicine can quickly push nations into famine or energy crises. Additionally, countries that have dollar-measured debt are coming closer and closer to defaulting as interest rates rise, a trend that is reminiscent of the 1980s Latin American debt crisis.
Maurice Obstfled, an economics professor at the University of California, Berkeley, authored a study which found that a strong dollar drags down global economic growth because of the pile-on effect, which leads other central banks to raise their own interest rates in order to bolster their currencies. Within the last week, Argentina, the Philippines, Indonesia, Sweden, South Africa, Norway and others have raised their interest rates in hopes of staving off inflation.
While the recent success of the dollar may benefit U.S. importers and American travelers, multinational corporations, foreign economies, and U.S. exporters are all feeling the adverse effects. Still, leading economists maintain that the global economy would be even worse off if the Fed didn’t work to contain U.S. inflation. Since financial and trade globalization has made national economies more connected than ever before, it is imperative going forward that central banks around the world consider the potential impacts of their actions beyond the domestic scope.