0619 GMT October 19, 2018
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 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 10-year bond yield has risen to 2.3 percent, from almost 1.7 percent on election night. Higher yields are a magnet for capital flows.
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.
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 percent of the world’s population and 60 percent 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 $10 trillion, 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.