The Federal Reserve’s decision to crush inflation at home by raising interest rates is inflicting deep pain in other countries — driving up prices, inflating debt payments and increasing the risk of a deep recession.
Posted at 1:00 p.m.
These interest rate hikes drive up the value of the dollar — the currency of reference for most trade and transactions around the world — and cause economic turbulence in rich and poor countries alike. In the UK and much of mainland Europe, the accelerating dollar is helping to fuel runaway inflation.
The pound hit its lowest level against the dollar last week as investors resisted a tax cut and a government spending plan. And China, which tightly controls its currency, pegged the yuan, also known as the renminbi, to its lowest level in two years while taking steps to manage its decline.
In Nigeria and Somalia, where the risk of famine is already present, the strong dollar is driving up the price of imports of food, fuel and medicine. The strong dollar brings indebted countries Argentina, Egypt and Kenya closer to default and threatens to discourage foreign investment in emerging markets like India and South Korea.
“For the rest of the world, it’s a no-win situation,” said Eswar Prasad, a Cornell economics professor and author of several books on currencies.
At the same time, he added, the Fed has no choice but to act aggressively to control inflation.
“Any delay in action could potentially make matters worse,” Mr. Prasad said.
Political decisions made in Washington often have wide-ranging repercussions. The United States is a superpower with the world’s largest economy and vast reserves of oil and natural gas. But their influence is outsized when it comes to global finance and trade.
The dollar is the world’s reserve currency, the currency that multinational corporations and financial institutions, wherever located, use most often to price goods and settle accounts. Energy and food are generally priced in dollars when bought and sold on the world market. The same is true for much of the debt of developing countries.
According to a study by the International Monetary Fund, almost 40% of global transactions are carried out in dollars, whether the United States is involved or not.
In recent days, the value of the dollar against other major currencies like the Japanese yen has hit a decades high. The euro, used by 19 countries in Europe, reached parity with the dollar in June for the first time since 2002. The dollar also hits other currencies, including the Brazilian real, South Korean won and Tunisian dinar .
One of the reasons for this is the series of crises that have rocked the world, including the coronavirus pandemic, the strangulation of supply chains, Russia’s invasion of Ukraine and the series of climate disasters that have put the planet’s food and energy supply at risk. In an anxious world, the dollar has traditionally been a symbol of stability and security. The more the situation deteriorates, the more people buy dollars. Moreover, the economic outlook in the United States, cloudy as it is, remains better than in most other regions.
The rise in interest rates makes the dollar all the more attractive for investors as it guarantees them a better return. This means that they invest less in emerging markets, which increases the pressure on these economies.
Price drops despite inflation
The unusual succession of events, which led to a weakening of global demand, further aggravates the situation of countries which otherwise could have taken advantage of the devaluation of their currency to export more of their own products, which have become cheaper.
A fragile currency can sometimes serve as a “buffer mechanism,” causing countries to import less and export more, Prasad explained. But today, many “don’t see the benefits of stronger growth”.
Yet they have to pay more for essential imports like oil, wheat or pharmaceuticals, as well as loan bills due to billions of dollars in debt.
A year ago, US$100 of oil or a US$100 payment of debt cost 1,572 Egyptian pounds, 117,655 Korean won and 41,244 Nigerian naira.
Suppose there was no price increase or inflation. Today, due to the rising dollar, that same $100 payment costs 1,950 Egyptian pounds, 143,158 won, and 43,650 naira.
American buyers, meanwhile, are getting a good deal. Last year, a 12-pound can of tea from the UK cost US$16.44, and today it costs US$13.03. A 50 euro box of Belgian chocolates went from US$58.50 to US$48.32. Cheaper imports are helping to contain inflation in the United States.
I can’t remember the last time it was said that a strong dollar was a way for the United States to export inflation, eliminating some of its own inflation, but adding some other all over the world.
Jason Furman, a Harvard economics professor who served as a senior economic adviser in the Obama administration
It is the most vulnerable who suffer the greatest setbacks. Poor countries often have no choice but to repay their loans in dollars, regardless of the exchange rate in effect when they borrowed the money. It was soaring US interest rates that triggered the catastrophic debt crisis in Latin America in the 1980s.
A new study on the impact of a strong dollar on emerging countries has found that it slows economic progress across the board.
“You can see the very pronounced negative effects of a strong dollar,” said Maurice Obstfeld, professor of economics at the University of California at Berkeley and author of the study.
This article was originally published in The New York Times.