Paul Gruenwald, chief economist at S&P Global, believes that there is only so much central bankers and economic policymakers around the world can do, and that politicians also have to play a heavy role in addressing the issue of a strong dollar.
ICE measures the dollar against a basket of currencies US dollar index (DXY) once approached 115 last month, a 20-year high, although it fell slightly earlier this month,DXY It is still up more than 17% so far this year and nearly 20% higher than the same period last year.
Why is a strong dollar a problem? While a stronger U.S. dollar helps ease domestic prices, it also weighs on major currencies, thereby amplifying inflationary pressures in other countries. In addition to raising concerns about market dislocations, the magnitude and speed of the dollar’s rebound is undoubtedly a major problem for emerging and developing economies that hold large amounts of dollar debt, as well as large U.S. multinationals that rely on overseas markets. The company is in an unfavorable situation.
Gruenwald presents four options for countries and economies struggling with a strong dollar, while explaining why none of them is ideal.
move forward fearlessly
Gruenwald pointed out that an excessively strong dollar could persist for several years, and that letting the domestic currency depreciate would lead to higher inflation, higher debt servicing costs and lower disposable income, and the credibility of policy makers would be damaged. The end result is to bring more political and economic costs to the country.
Use foreign exchange reserves
Gruenwald believes that this is not a successful strategy. Although intervention in the foreign exchange market will help to slow down the rate of depreciation, if the devaluation pressure remains strong and continues, the efforts will be fleeting.
He believes that foreign exchange reserves are usually used to stabilize the exchange rate when the market encounters turbulence, rather than to deal with continuous depreciation pressure.
Implement capital controls
Restricting foreign exchange trading is an attractive but potentially ineffective approach.
Gruenwald said that this move may lead to black market transactions or double the exchange rate. In the case where only insiders can obtain foreign exchange, it will lead to market distortions and shocks, and at the same time, it will damage the credibility of the currency and affect its future use in overseas trading markets. .
Rate hikes to offset devaluation pressures
Raising interest rates is the textbook answer, but there are corresponding problems. If policymakers do the right thing and use higher interest rates to tighten financial conditions, lower inflation, and ensure sustained economic growth, then currency depreciation means that interest rates must rise further. This is the “Mundell Paradox” of international finance. trilemma), essentially representing higher interest rates and lower output and employment, caused by inflation imported from other countries.
The “Trilemma” principle was put forward by the well-known economist Robert Mundell, which advocates that a country cannot take into account a flexible monetary policy, a fixed exchange rate and the free flow of capital at the same time, and can only choose two out of three.
Other possible actions are global, ranging from currency swaps with other countries to drafting a 1985 Plaza Accord-style agreement.
Gruenwald believes that the ultimate solution depends not only on economics, but also political ones.
“When a strong dollar has more negative effects on other economies than it benefits the U.S., it is too strong,” he said. “It’s hard to measure accurately, but one way to ask is: What would a benevolent policymaker do? What kind of decision to make?”
Gruenwald said: “In a way, a strong dollar is not the best outcome for everyone involved, and if the market doesn’t correct, the solution will be political, and the dollar boom of the 1980s culminated in the signing of the square. The deal is over, the cast may be different this time, but the ending may be the same.”