By William Watts
The US dollar is consistently compared to a “wrecking ball” when discussing the economic and market chaos caused by its outsized rally in 2022.
But central bankers and other economic policymakers are limited in what they can do, warned Paul F. Gruenwald, chief global economist at S&P Global, in a note Thursday. To address the factors really driving the dollar’s rally, politicians will have to do the heavy lifting, he argued.
See: Why an Epic US Dollar Rally Could Be a ‘Wrecking Ball’ for Financial Markets
How strong is the dollar? The ICE US Dollar Index, a measure of the currency against a basket of six major peers, hit a 20-year high of just under 115 last month before declining in early October. It’s up more than 17% year-to-date and almost 20% over the last 12 months.
The British pound fell to an all-time low against the US dollar last week as Britain plunged into a financial crisis. The euro has fallen below parity against the dollar and the euro zone is expected to suffer a brutal winter slowdown as a result of the energy shock caused by Russia’s invasion of Ukraine. The Japanese yen recently traded at its lowest level against the US dollar since 1998, prompting a rare round of intervention by the Bank of Japan.
See: Don’t look for a bottom in the stock market until a soaring dollar cools. Here’s why
Why is a strong dollar a problem? While a stronger dollar is helping to keep US inflation under control, the depreciation of competing currencies is fueling inflation in those economies. The magnitude and speed of the dollar’s rally has fueled fears of market dislocation and tensions in emerging and developing countries, which carry large amounts of dollar-denominated debt. The dollar’s gains are also seen as a negative for US large-cap multinationals that rely on international selling.
Read below what Gruenwald had to say about the four options available to countries and economies struggling against a strong dollar – and why none of them are ideal:
There are also “global options,” the economist notes. These include dollar swap lines with other countries, such as those extended or initiated in early 2020 when a global scramble for the US currency sent the greenback higher as the COVID-19 pandemic battered the global economy. While swap lines have proven effective in such situations, it is not clear that they would be appropriate for rising dollar valuations, Gruenwald wrote, “because they are comparable to additional reserves: they are likely to be used to defend an exchange rate level.”
And then there’s the big one. A Plaza Accord-style deal between major economies. In the Plaza Accords of 1985, the Federal Reserve and the central banks of Germany, Britain, France, and Japan agreed to intervene to devalue the US dollar, which Gruenwald described as the “mother of all… appreciations.” ”
See Also: Why a Rising Dollar Raise Questions – and Doubts – About Plaza Accord-Style Intervention
But although the current pain of dollar strength is becoming apparent and growing, the DXY is still three to four standard deviations from its 1985 peak, he said, noting that the focus at the time was trade imbalances and China was not part of the discussion given its small economy at that time.
At some point, the pain can become too much to bear.
“Ultimately, the solution will not only depend on the economy, but also on politics,” wrote Grünwald.
Dollar strength “becomes excessive when it begins to hurt other economies more than it benefits the US. Accurately measuring this is difficult, but one way to gauge this is to ask: what would a global, well-meaning politician dictate?” he wrote.
At some point, a strong dollar becomes suboptimal for all parties involved, “and unless markets correct, there will be a political element to the solution,” Grünwald wrote.
The extremely – and persistently – high US dollar of the 1980s was eventually brought down by the Plaza Accord, he noted. “The actors may be different this time, but the endgame might end up looking the same.”
– William Watts
(ENDS) Dow Jones Newswires
10-08-22 1259ET
Copyright (c) 2022 Dow Jones & Company, Inc.
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