The Debate About the Strong Dollar and Its Consequences Is Beginning to Emerge in America.
Concerted action by central banks to calm the strength of the dollar, as was the case with the Plaza Accords in 1985, is still far from being on the agenda.
Will the strong dollar begin to be debated in the United States? Washington has so far been satisfied with the strength of the greenback: the currency's strength, firstly, has confirmed its status as a safe haven in times of geopolitical unrest. The strength of the U.S. dollar, secondly, acknowledges the U.S. lead in the growth and interest rate cycle: with a faster rebound in activity after the pandemic and now vigorous monetary tightening, the rise of the dollar against other currencies reflects the growth and interest rate differential in favor of the U.S. - capital is pouring in.
However, nuances are beginning to emerge, both in the discourse and in the analysis.
For the moment, there is no major concern from the US administration, but we are starting to see the Fed talk about the international effects of the strong dollar. Recalling the more than 10% appreciation of the dollar since the beginning of 2022, Fed Vice Chair Lael Brainard said on Friday, September 30, 2022, that this tends to “reduce import prices in the United States,” making the Fed's job easier.
“But in some other jurisdictions, the corresponding depreciation of the currency may contribute to inflationary pressures and require additional tightening to offset them,” she also acknowledged.
In the face of the dollar's rise this year, “you might be concerned about the risk of financial contagion,” Thomas Barkin, president of a regional branch of the Federal Reserve, also conceded on Monday, October 3, 2022. “There's a whole bunch of reasons to worry about it. It should keep me up at night,” he said, recalling that many countries borrowed in dollars - including emerging countries.
However, he said, “our mandate is to help the American economy work. So we have to be concerned about the impact on the American economy.”
For now, U.S. exports have held up. But as results are released, internationally active U.S. companies are beginning to grumble about the strength of the dollar. On the other hand, the strong dollar could facilitate acquisitions of foreign companies, which have become less expensive for American investors.
Financial markets are “working well”
The impact of the strong dollar on trade is actually relatively limited, according to some analysts. 80% of U.S. imports are paid for in dollars, and when it comes to exports, we remain in an environment where demand trumps price. The issue of the strong dollar is therefore more financial than economic.
The hypothesis of concerted action by central banks to calm the strength of the dollar, as was the case with the Plaza Accords in 1985, is still far from being on the agenda. “I don't think we're headed in that direction,” National Economic Council Director Brian Deese said last week.
“It's hard to talk about collaboration in a world where people have very different interest rates. If you remember, there have been coordinated decreases and increases at different times, but we are in very different situations,” also judged, on September 21, 2022, by the president of the Fed, Jerome Powell.
The financial markets “are working well,” Treasury Secretary Janet Yellen agreed. We could find ourselves in a situation where central banks and fiscal authorities put more pressure on the Treasury to encourage a weakening of the dollar in the months to come. However, there is no guarantee of success: Janet Yellen is not in favor of a weak dollar. And the Fed is still in an interest rate hike phase.
By tacitly assuming the risk of a recession induced by its aggressive monetary tightening, however, the Fed could help calm the dollar level in the medium term. According to Oxford Economics, “the dollar will remain strong this year and weaken next year.” But not to the exclusion of upside risks, such as “more resilient U.S. growth relative to the G7, better equity market performance, and a more pronounced rate hike cycle than we currently expect.”
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