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Home›Global Wealth›The greenback’s rapid rise increases risks for the global economy

The greenback’s rapid rise increases risks for the global economy

By Clint Kennedy
May 17, 2022
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So far, there has been little political backlash to a development that is eroding US competitiveness and contributing to its record trade deficit. In the past, such rises in the dollar have threatened trade wars. Today, strength in the US labor market countered potential tensions.

Yet the absence of US political antagonism to the rising dollar does not mean that it is easy to navigate towards global economic and financial stability. The risks are particularly acute for developing countries already facing the clear and present dangers of the economic, energy, food and debt crises.

For most of them, the appreciation of the dollar translates into higher import prices, more costly external debt servicing and an increased risk of financial instability. This puts additional pressure on countries that have already exhausted their resources and policy responses by battling the ravages of COVID-19.

The concern is particularly acute for low-income countries, also hampered by high food and fuel inflation. The cost of living crisis here is also a threat of starvation for the most vulnerable.

If left to burn longer, what I have called the “little fires everywhere syndrome” – that is, the increasing instances of economic and financial instability in countries – can turn into a more greater and more dangerous of damaged global growth, defaults and social problems, political and geopolitical instability.

The repercussions on advanced economies are potentially more problematic than any direct effect on them of the appreciation of the dollar. In addition to weakening the external growth engines of these economies at a time of growing stagflation at home, a destabilized developing world can increase volatility in financial markets that already face multiple risks.

Financial markets have already had to deal with a significant increase in interest rate risk due to the persistence of high inflation which has taken the Federal Reserve massively out of play.

In the process, the turmoil in government bonds spread to other segments of the market as concerns over tighter financial conditions began to mount. Now, markets need to worry more about slowing global economic growth.

As unpleasant as the destruction of wealth has been this year, its impact on economic activity has been muted and the risk of market functioning has yet to be felt. crypto carnage, as well as repeated price gaps in global US Treasury market benchmarks.

Even if this were to turn into something bigger due to payments disruptions in the developing world, the Fed would be hard pressed to return to its usual policy of flooding the markets with liquidity given its bloated balance sheet and its inflationary concerns.

The way to reduce the risks associated with the dollar appreciating too quickly is for the rest of the world to move faster with structural reforms that boost growth and productivity, improve returns to capital, and increase economic resilience.

Without it, the theoretical promise of orderly global adjustment, including external impulses for underperforming countries, would become a difficult source of economic and financial instability.

The writer is president of Queens’ College, Cambridge and an advisor to Allianz and Gramercy.

FinancialTimes

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