The Dollar is Moving, Now Come the Reverberations
The dollar is on a tear. The greenback has hit a new 20-year high and the fundamentals are there for more upward movement. Governments and industries are making the necessary adjustments, but there are a host of variables that are ever-evolving and difficult to predict moving forward.
After the 2008 financial crisis, the US pushed hard to devalue the dollar. The Federal Reserve played a principal role, and it is inserting itself once again. In terms of the US’s major trading partners – Japan and the EU – the dollar is the strongest against the yen since 1998 and at near parity with the euro for the first time since 2002. The increasing price of natural gas is the main driver behind the dollar’s leap. Russia’s incursion into Ukraine didn’t help, and pundits predict investment to be routed away from Europe and certain parts of Asia and over to the US.
Energy-intensive industries will find an attractive US market. Fracking had already made the US energy self-sufficient, and Germany and Japan most notably are suffering from soaring import costs driven by energy. Germany is a country accustomed to running massive trade surpluses. Yet, in May the European power registered its first trade deficit in goods since 1991.
On a global scale, a strong dollar will contribute to rising inflation. Commodities like timber or meat as well as petrol are primarily traded in dollars. When the dollar gets stronger, and local currencies weaker, non-elastic items like fuel, food, and construction supplies cost more. The bet from the Fed, however, is that Stateside a stronger dollar will result in cheaper consumer imports with the hopes of easing inflation.
While imports might be cheaper, exports from the US will be more expensive. A prolonged strong dollar contributes to a widening US trade deficit. The US trade deficit is already roughly $1 trillion per year with multiple presidencies having vowed to shrink it. In terms of countries that owe their debt in US dollars, the debt will only widen as the dollar appreciates. Lower-developed countries have a long history of taxing their economies more, issuing inflationary local money, and even increasing borrowing in the face of paying down dollarized debt when the dollar grows stronger. The results are predictable and unfortunate in most cases – hyper-inflation, recessions, a sovereign debt crisis, or some mix of the three.
Returning to Europe, a rising dollar creates pressure for the European Central Bank to bump its interest rates. The justification is to dampen the cost of imports and prop up the euro. Yet, the eurozone is a big zone with a range of member countries. Some hold high levels of debt, namely Italy, with an unreal 150% of GDP. Returns to bail-out talks could get louder if major economies like Italy and others cannot sustain their debt levels and need to be rescued.
The dollar is on a tear, and while some industries will certainly benefit, a strong dollar is not a harbinger of good things on the global level. The dollar is a classic safe haven for a reason. The world is not overly safe at the moment.