The remarkable strength of the US dollar these days has already driven the euro to nadirs where the question of parity with the greenback is being debated as one of “when” rather than “if” and Britain’s pound sterling is near five-year lows. The USD’s dramatic runup and the plunge of the euro are being hailed by firms in Europe and elsewhere as a much-needed development that will iron out deep-seated distortions in the global picture by boosting the exports of countries with devaluing currencies, promoting investment, and ending deflation. It will make the United States a country with sharply rising imports and, thus, the engine of global growth, which is as it should be, since the US economy, unlike its European counterparts, is currently doing well.
It is rare, though, that a major currency shift has consequences that are this straight-forward and predictable, and there are, on all sides, negative repercussions to be concerned about. In the United States, companies that export are now seriously handicapped by the high-flying dollar, which makes it impossible for many to stay internationally competitive. Also, enterprises active abroad find their overseas earnings greatly diminished when they are translated into US dollars. Harsh weather has already slowed output in the first quarter of the year. Adding the problems US companies have with the relentless strength of the dollar there will be headwinds that could keep overall economic growth in the United States below 3% for 2015 as a whole.
With this, the US would not provide much of an engine for the global economy. Moreover, it is by no means certain that the tumbling euro and the European Central Bank’s loose-money policies will lift the Eurozone out of its prolonged malaise. For one thing, Eurozone countries trade largely with one-another. In such transactions the exchange market value of the euro does not matter. The average of export and import goods traded with countries outside the euro area makes up less than one-fifth of the Eurozone economy. And where the weakness of the euro does matter, it will benefit mainly net trade in countries with a strong export sector, such as Germany, which are not the ones currently needing help.
Also, the strongest drivers of trade growth are, in many instances, not relative exchange rates. There are other factors such as geographic distance from a market, how well sales territories are currently performing and the productivity of exporting countries, with currency strength often being more an after-thought. The last time the euro dropped through parity was more than a decade ago, a year after its creation, when many investors still doubted the new currency would last. At that time, the euro plunged by one-fourth between January 1999 to October 2000. But the big devaluation did not trigger much of a lasting upturn in European exports. Nor did the one in Japan that occurred between 1995 and 1998, when the yen lost roughly 40% of its dollar value and the benefit for exporters was swamped by other factors.
Elsewhere, the situation is not clear-cut, either. The Korean won, for instance, has dropped by around 11% against the dollar since last Summer, but it has gained 9% against the Japanese yen over the same span. In fact, it is up versus the JPY by 60% over the past three years. So, Korean exporters are not likely to benefit much. In many emerging markets, moreover, the authorities are now concerned that the short-term capital inflows on which they had relied to bridge their current-account BoP deficits may reverse due to the lure of the US dollar and the prospect of higher interest rates in the US. Quite a few – such as those of Turkey and Mexico – are intervening to support their currencies.
This is part of what the Basel-based Bank for International Settlements (the “Central Bankers’ bank”) has been warning of when it recently said emerging markets will find their financial fragilities exposed by the strength of the dollar. The soaring greenback certainly does not augur well for the many developing countries, or for individuals and companies in these nations, that have taken advantage of the exceptionally low USD interest rates to take out loans in dollars, only to find now that the rapid depreciation of their own currencies against the USD has ratcheted up principal and instalment payments to a point where the debt becomes extremely onerous to service. They would like to raise their interest rates to give their currencies support, but find this nearly impossible to do, given the weakness of their economies.
Then, too, the bad thing about currency depreciations is that they lift import prices and can lead to higher inflation. Right now, this is not much of a problem for most countries, except some in Latin America. But the enormous liquidity which the US Federal Reserve, the Bank of Japan, and now the European Central Bank have been pumping out with their QE (quantitative easing) bond purchases will be a lingering problem more likely to create asset bubbles than to give economies a lasting push. A stronger dollar may lessen some of the fundamental imbalances in the global economy. But in the process it hurts many and brings new problems in its wake.
[March 16, 2015]