The Rise of US Dollar is Bad for Global Economy; Here's Why a Decline is Inevitable

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The US dollar's inexorable rise is throwing global forex markets into a tizzy and causing new uncertainties for the global economic outlook. The Greenback has been performing well against other major currencies since the middle of last year, but its dominant position became sharper in the last few months.

Rise and Rise of Dollar

Dollar has now appreciated 21 percent against the UK's pound sterling, sending the British currency to its lowest point in many decades. Against the Japanese Yen, the dollar has gained as much as 20 percent as well. The greenback is up 15 percent against the Euro and the Thai baht as well, while its gains against the Indian rupee and the Chinese yuan have been considerable.

The Dollar index, which shows how the greenback sits in comparison with the euro, yen and other major currencies, has surged more than 14 percent this year alone.

US Banknotes
WASHINGTON D.C., March 20, 2020 (Xinhua) -- Photo taken on March 19, 2020 shows US dollar banknotes in Washington DC, the United States. The Trump administration's plan to send Americans relief money as part of a massive stimulus package in response to COVID-19 could be 1,000 U.S. dollars per person, and 500 dollars per child, Treasury Secretary Steven Mnuchin said Thursday Xinhua/Liu Jie/IANS

Stocks, Gold, Cryptos Plunge

Even as the dollar is rising relentlessly, other asset classes have been declining. While the US stocks have dropped more than 19 percent, the value of once-soaring bitcoin has more than halved. Gold, which is seen as a safe haven asset in time marked by crises, has also lost more than 7 percent.

What's Driving Dollar?

This seemingly relentless dollar surge is happening at a time when the US, the world's largest economy, is grappling with the worst inflation in four decades. So why is the dollar rising? Chief among the factors is the increasing confidence in the US economy. Despite high inflation and a not-so-comfortable balance of trade scenario, the US economy is adding jobs and driving confidence in the fundamentals. The second conspicuous factor behind the dollar's rise is the Federal Reserve's open and aggressive support to the currency, which is underscored by a series of rate hikes. Thirdly, the world is grappling with crises like the Ukraine war -- and an unprecedented energy crisis caused by it -- as well as a remarkable slowdown in China caused primarily by its zero-Covid policy. These crises fuelled dollar's value as a safe-haven asset.

Representational image pixabay

What are the Impacts?

Dollar's surge would naturally appear to be great for the Americans, but that's not entirely true. While of course, imports will become cheaper and foreign jaunts will bleed Americans less almost anywhere in the globe, there are negatives as well. According to analysts, the unusually strong dollar is eating into corporate profits, which will have a sustained, trickle down effect on the overall economy.

Impact on Rest of the World

While major currencies across the world have received severe drubbing, the impact is not limited to the currency markets. The rising dollar will be bad for the economies of the emerging world. The hardest hit are countries with high debt levels and high import bills. "The longer and higher the dollar soars above the rest, the greater the risk of more prolonged global stagflation, debt problems in the developing world, more restrictions on the free flow of goods across borders, greater political turmoil in fragile economies and greater geopolitical conflicts," says Mohamed El-Erian, the president of Queens' College at the University of Cambridge.

UK Pounds
UK Pounds PxHere

Threat to Risk Assets

According to Morgan Stanley analysts, the unseemly rise of the dollar is posing threat to the risk assets like stocks. Many brokerages have already predicted that the worst is yet to come for the US stock markets. Morgan Stanley strategists say the dollar rally is creating an untenable situation for the stock markets. They also point out that similar dollar surges in the past have triggered financial or economic crises like the 2008 global crisis or the 2012 sovereign debt crisis. "While hard to predict such 'events,' the conditions are in place for one ... ," says Morgan Stanley's chief US equity strategist Michael Wilson.

Will Dollar Reverse Gains and Decline?

Most analysts believe that the dollar rally will end, and the greenback will actually start declining. They point out that big spikes in the dollar, like in the mid-1980s and the early 2000s ended up with large declines. The analysts don't exactly place a finger on when this would happen during this cycle, but there are some straws in the wind. First, if the US inflation peaks and the Fed halts its aggressive rate raising, the dollar rally will end. A resurgence in the Chinese economy and an easing of the European energy crisis will also be useful catalysts in this process.

However, these can take time. "At least some of these need to happen to slow the unprecedented surge in safe-haven inflows into the US. We fear that none of these pieces are yet falling into place," said George Saravelos, Deutsche Bank's head of foreign exchange research, according to DW.

This article was first published on September 27, 2022