The US dollar is looking increasingly threatening, amid strong economic growth in the US and expectations of a delay in interest rate cuts by the Federal Reserve.
Liquidity has returned to the US markets, and the “greenback” has risen in price by 4% since the beginning of the year compared to other leading currencies, writes The Economist.
With the upcoming presidential election in the country, both Democrats and Republicans are determined to boost American manufacturing, and the world is on the cusp of a new difficult geopolitical period.
The situation is also complicated by the fact that the strength of the US currency reflects weakness elsewhere. By the end of 2023, the US economy was 8% larger than it was at the same time in 2019. Those of Britain, France, Germany and Japan grew by less than 2% over the same period.
The Japanese yen is at a 34-year low against the dollar, and the euro has fallen to $1.07 from $1.10 earlier in the year. Some traders are already predicting that the two currencies will reach parity by early next year.
Are new currency wars looming?
If Donald Trump wins the election in November, new currency wars may break out on the scene. A strong dollar tends to raise the prices of US goods abroad and lower the prices of imports, which would widen the country’s persistent trade deficit.
According to Trump, this has been a problem for many decades, and Robert Lighthizer, the architect of the former US president’s customs policy against China, wants to weaken the dollar.
Current President Joe Biden has so far made no public statements about the currency’s strength, but the strong dollar also complicates his program to boost domestic manufacturing.
Elsewhere, the powerful greenback is good for exporters whose expenses are denominated in other currencies. But high US interest rates and a strong dollar are generating “inflation imports” that are now being exacerbated by relatively high oil prices. In addition, companies that have borrowed in dollars face higher interest costs.
Earlier this month, the head of the International Monetary Fund, Kristalina Georgieva, warned about the impact of these developments on global financial stability.
Many countries have significant foreign exchange reserves that they could sell to strengthen their currencies. Japan, India, and South Korea hold $1.3 trillion, $643 billion, and $419 billion, respectively. But any such relief would only be temporary.
Although the selloff slowed the dollar’s strengthening in 2022 when the Fed began raising interest rates, they did not stop it. Central banks and finance ministries do not want to waste their assets in fruitless fights.
Another option is international coordination to deal with greenback appreciation. A little over a week ago, the finance ministers of the US, Japan and South Korea expressed concern about the sharp decline in the yen and won.
The announcement could be a precursor to further interventions in the form of joint sales of foreign exchange reserves to prevent further weakening of the two Asian currencies.
Strong Dollar or Weak World Currencies?
But even if the leaders of these countries want to act as one, their economies inevitably divide them. After all, the weakness of the Japanese yen and the South Korean won is due to the difference in interest rates between the US and the rest of the world.
South Korea’s two-year government bonds offer a return of around 3.5% and Japan’s just 0.3%, while US Treasuries maturing at the same time offer 5%. If interest rates remain significantly higher in the US, investors seeking returns face a clear choice and their decisions will be in favor of the dollar.
There are also countries with which America is less likely to cooperate. According to US bank Goldman Sachs, China recorded about $39 billion in foreign exchange outflows in March as investors fled the country’s depleted economy. This is the longest such trend since 2016.
The yuan has weakened steadily against the dollar since the start of the year, with depreciation accelerating since mid-March. Since then, the rate has risen from 7.18 to 7.25 yuan per dollar. Bank of America expects it to reach 7.45 by September, when the US presidential election campaign will be in full swing.
That would put the yuan at its weakest since 2007, providing a boost to the Chinese government’s latest export drive. China’s cheap electric vehicles could get even cheaper, angering US politicians.
Even protectionists in the US may be willing to overlook weak allies’ currencies, at least for a while. But they are unlikely to do that for China, raising the risk of further tariffs and sanctions and perhaps even putting the country back on the US list of so-called currency manipulators.
As long as the US economy performs better, the dollar is likely to remain strong. And while US policymakers see this as cause for concern, trade tensions may also be starting to rise.
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