So far, there has been little political pushback to a development that erodes US competitiveness and contributes to its record trade deficit. In the past, such rises in the dollar have threatened trade wars. Now America’s strong labour market has countered potential tensions.
Yet, the lack of US political antagonism over the dollar’s ascent does not mean that it’s smooth sailing for global economic and financial stability. The risks are particularly acute for those developing countries already facing the clear and present dangers of crises over the economy, energy, food and debt.
For most of them, dollar appreciation translates into higher import prices, more costly external debt servicing and greater risk of financial instability. It puts further pressure on countries that already stretched in resources and policy responses by the fight against the ravages of COVID-19.
The concern is particularly acute for low-income countries hampered also by high food and energy inflation. A cost of living crisis here is also a threat of famine for the most vulnerable ones.
If allowed to burn further, what I have called the “little fires everywhere syndrome” — that is, multiplying country cases of economic and financial instability — can merge into a bigger, more dangerous combination of damaged global growth, debt defaults, and social, political and geopolitical instability.
The spillbacks to the advanced economies are potentially more problematic than any direct effect on them of dollar appreciation. In addition to weakening the external growth engines of such economies at a time of growing stagflation at home, a destabilised developing world can add volatility to financial markets that are already dealing with multiple risks.
Financial markets already had to navigate a significant increase in interest rate risk owing to the persistently high inflation that has caught the Federal Reserve massively offside.
In the process, the disruptions to government bonds spread to other market segments as the concerns over tightening financial conditions started to mount. Now markets have to worry more about slowing global economic growth.
As unpleasant as the wealth destruction has been this year, its impact on economic activity has been muted and the risk of market functioning has yet to kick in. Having said that, for those with sharp noses, there is already some scent of this owing to the crypto carnage, together with repeated price gapping in the US Treasury market’s global benchmarks.
Even if this were to develop into something bigger because of payments disruptions in the developing world, the Fed would find it tricky to revert to its usual policy of flooding the markets with liquidity given its bloated balance sheet and inflationary concerns.
The way to reduce the risks associated with too rapid a dollar appreciation is for the rest of the world to progress faster with structural reforms that enhance growth and productivity, improve returns on capital and increase economic resilience.
Without that, the theoretical promise of an orderly global adjustment, including external boosts for underperforming countries, would become a challenging source of economic and financial instability.
The writer is president of Queens’ College, Cambridge, and an adviser to Allianz and Gramercy.