Rising Dollar Spells Trouble

V P Nandakumar,

MD & CEO of Manappuram Finance

King Dollar is crimping private consumption everywhere in the world as the high
cost of imported goods burns holes in consumers’ pockets not just in the
US but elsewhere in the world

Over the past few months, the word `de-dollaraisation’ is fast gaining currency everywhere in the world. It may be perhaps one of the most searched word on the world wide web after the Ukrainian War, inflation and other such trending words and phrases.

The reason for the growing interest of netizens in `de-dollarisation’ is not hard to find. The unfettered appreciation of the US greenback has been creating headaches not only for the consumers of import dependent countries but also for the central bankers on both sides of the Atlantic. I will explain the reasons for this in a while. Before that, if truth be told, in the first-place, king dollar is crimping private consumption everywhere in the world as high cost of imported goods burns holes in consumers’ pockets not just in the US but elsewhere in the world as well.

For the sake of context, the US dollar has been appreciating against all the major currencies including pound sterling, Euro and of course Indian rupee steadily despite occasional retreats now and then. The DXY or the dollar
index, the go-to-gauge that tracks the greenback’s movements against a basket of currencies, has appreciated almost 3% during the past one month alone. This means that all other currencies in the basket have lost almost 3% of their values by none of their own fault.

The chief reason behind the spurt in dollar value is higher and higher interest rates in the US and officials of the US central bank or Federal Reserve say they are probably not done yet since inflation in the world’s largest economy remains way above the tolerance limit of the US Fed. This means that, to use a common disclaimer used by economists, ceteris paribus or other things remain the same or constant, the Fed will keep hiking policy rates till the price levels in the US cool off to 2% or below. (2% is the upper tolerance band for inflation fixed by the US Fed for the economy to reach full employment or equilibrium.)

Of course, one could leave the issue to settle down in the US by saying that it is their problem. But unfortunately, it is not just the problem of the US administration alone. Thanks to the status of the dollar as the global currency, since most traded commodities like oil, fertilizer, not to mention gold, are priced in the US dollar, a run-away appreciation in the US currency invariably has its impact on other economies. To say the least, most oil importing countries are importing inflation since oil prices move up with every point increase in the value of the dollar.

That is just one side of the issue. Many export-led economies are facing a classic situation which can best be called as `immiserizing growth’ as postulated by noted Indian economist Jagdish Bhagwati in the 1950s. `Immiserizing growth’ is an economic episode where growth could result in a country being worse off than before the growth. This is because if growth is heavily export driven, it might lead to a fall in the terms of trade of the exporting country. In rare circumstances, this fall in the terms of trade may be so large as to outweigh the gains from growth. Many commodity exporting countries are facing such a curious situation as terms of trade turn against them.

Also, it is only logical to argue that appreciating dollar has stoked inflationary fire in other economies through the high cost of imported items. We in India have experienced this but for a short-time since synchronized policy actions by the RBI and the Government, have finally brought key inflation gauges under the upper tolerance band of the RBI.  But remember that many other countries were not as fortunate as India as run-away inflation has almost crushed the economies of some of our immediate neighbours.

Another direct effect of the super dollar along with high Fed funds rate is the flight of yield chasing capital denominated in US currency to the United States of America. This has been putting tremendous pressure on central
banks’ coffers since they are ultimately responsible for settling trade payments. This phenomenon has been forcing many central banks including the RBI to look for other options to settle trade in local currencies. This, in my view, is the chief reason behind the growing popularity for `de-dollarisation’.

On the balance, an appreciating US greenback is bad news for consumers of the world since it inter alia stokes inflationary fire across economies. This is equally true not only for the consumers in countries like India or Australia or France but also for the US as well. This is why an unbridled appreciation in the dollar’s value is said to be against everybody’s interest.

Pic Courtesy: google/ images are subject to copyright