The US dollar’s relative value to other significant currencies has risen to its greatest level since the early 2000s. The currency keeps rising even as concerns about a recession grow and the economy shows signs of weakening.
The US dollar (USD), which has been steadily increasing over the past year or so, surpassed the Euro this month for the first time in twenty years. The Japanese Yen has also dropped significantly in value relative to the USD.
A strong dollar can lower the price of goods imported into the country and lower the cost of travel for Americans. Large multinational companies like Johnson & Johnson have recently said they are worried that the strengthening dollar will cut into their profits. This is because when foreign sales are converted back to dollars, they lose value, and because their products are more expensive abroad, they are less competitive with local businesses.
Economic policymakers and representatives of the Biden administration have asserted that a strong currency may even contribute to reducing the rate of inflation in the US, which has been rising at its fastest rate in forty years. Economists think the effect would be small but still helpful, since many households struggle to pay for things like food, rent, and gas.
The global economy is significantly impacted by a strong dollar, which devalues other currencies. The value of the dollar is important for emerging economies because it affects how likely it is that they will not pay back their loans.
Factors affecting the strengthening dollar
- The Fed is a significant contributing factor.
The Federal Reserve’s new interest rate strategy is the main cause of the dollar’s enhanced strength. The central bank set its target interest rate for the year at between 0% and 0.25%, but has since increased it three times, taking it to between 1.50% and 1.75%, with the threat of additional hikes in the future.
The aggressive tightening of the Fed’s monetary policy is making it more desirable to hold dollar deposits in interest-bearing accounts in the United States due to the extremely low rates across the developed world, including in Europe, where the European Central Bank has lagged in raising interest rates. As a result, the dollar’s value increases in comparison to other major world currencies.
For reasons other than interest rates, such as perceived safety and superior economic development prospects, many foreign investors are moving their assets into the United States and away from other wealthy countries. Due to the uncertainties brought on by the war in Ukraine, this is particularly happening across Europe. Much of the natural gas that Europe requires to run its companies and heat its homes is controlled by Russia, which the West has strongly sanctioned for its aggressiveness. It is not clear whether future restrictions on supply will hurt economic growth.
- American effects
The impacts of a strong currency in the US are uneven. Americans will discover that their money goes farther than it ever did while vacationing abroad, often considerably further. A strong dollar also makes it cheaper to buy goods from countries whose currencies have lost value against the dollar.
Consumers in the United States will benefit from the lower import costs at a time when high inflation is raising prices. That relief, though, will only be temporary. Despite the dollar’s advances against a variety of foreign currencies this year, the gains against the currencies of Canada, Mexico, and China—the three biggest trading partners of the United States—have been the smallest.
There are some negative effects, though.
According to Reinsch, it’s bad for American manufacturers or anyone who exports from this country because it raises the cost of their goods. “The already significant trade gap will grow as a result. Therefore, decision-makers must choose their poison. Which do you want, increased trade deficits or inflation? “
According to Reinsch, when the dollar has been strong for a while, there is frequently a political backlash in the United States, and eventually the Fed will face pressure to decrease rates in order to increase the competitiveness of American goods in the world market.
- Impact on a global scale
Maurice Obstfeld, a senior fellow at the Peterson Institute for International Economics who doesn’t live there, says that a strong dollar can hurt the global economy and, in particular, emerging market countries.
According to him, slower growth and lower volumes of foreign trade are related to a stronger dollar on a worldwide scale. Particularly open, developing economies suffer from that. It is linked to decreasing commodity prices, which harms exporters of such commodities.
A strong dollar can be particularly difficult in poor countries, according to Obstfeld, a professor of economics at the University of California, Berkeley, and the former head economist of the International Monetary Fund. This is because a strong dollar is linked to a drop in demand, a smaller GDP, and higher costs to pay off debt.
According to him, emerging nations are increasingly able to issue government debt in their own currencies, but they still borrow in foreign exchange, and their firms, particularly those with an international focus, have significant debt that is denominated in dollars. When the value of the dollar goes up, all of these debts tend to get more expensive, which makes the financial situation in emerging markets worse overall.
When asked how long the current cycle might continue, Obstfeld responded,”In the short run, with all this pressure on emerging economies, we’re likely to see their currencies depreciate more against the dollar. That alone would tend to strengthen it. So, I think we’re in this place for a little while.”
But he continued,”Over the course of six months, if the U.S. moves into recession and the Fed begins to lay out a loosening course, provided other countries aren’t in even worse shape than the U.S., you could see the dollar start to come down a little.”
