A Strong Dollar Could Cause Global Economic Collapse
In a recent article, The Economist advised against celebrating the rising U.S. dollar too soon. Indeed, the inevitable hike in the value of the dollar, resulting from a higher federal interest rate, only seems like a good idea. (Source: “Why a strengthening dollar is bad for the world economy,” The Economist, December 1, 2016.).
Donald Trump’s election as president has sparked one of the fastest increases in the value of the dollar ever. This has been the case, especially when compared to other major global currencies. The dollar is now trading some 40% higher than it was in 2011. Now, many foreign borrowers will find themselves stretching to pay back loans, risking a major economic collapse.
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Meanwhile, China’s yuan, which recently earned a spot in the IMF’s basket of reserve currencies, has collapsed. It’s trading at its lowest level against the dollar since 2008. Donald Trump has accused China of deliberately devaluing its currency. Yet, capital flight from China seems to explain this sharp devaluation better.
But it’s not just China, notes The Economist. India, one of the fastest developing economies in the world, has also suffered. Its currency also reached its lowest level against the greenback. And this goes for most other Asian currencies. They are exploring depths not reached since the 1997-1998 financial crisis—triggered by the Thai baht.
The only explanation for the dollar’s exuberance is that President Trump will cut taxes. Somehow, he will also boost the economy using infrastructure repair and improvement as the launchpad.
But, analyzed through the lens of history, Trump’s plan is a near repeat for President Ronald Reagan’s first term. This was a period of big budget deficits and high interest rates. The dollar surged compared to the many European currencies at the time (there was no euro then).
But since Reagan’s time, the rise of new economies (thanks also to the end of the Cold War) has made the dollar more important than ever. The global influence of financial markets has also exploded since then. That’s why a stronger dollar could accentuate problems and become toxic for the U.S. as much as the rest of the world.
The more emerging markets—like China or India—get richer, the more their need for dollars. But, because of the season of low interest rates, many pension funds have sought higher returns elsewhere. They borrowed in dollars to take advantage of low rates.
Therefore, as the dollar rises, so does the cost of servicing debt, writes The Economist. Similarly, the low-cost borrowing in dollars increased credit supply. This fueled low-cost borrowing abroad. A rising dollar reverses this cycle. Loans will be more expensive to repay and it could slow or entirely collapse the global financial system.
