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Alain Boublil Blog


The dollar increase : Why and how far?

The dollar has experienced a spectacular increase these last months against all the major currencies in the world. For a year, it has appreciated itself by 15.2% against the euro and by 17.6% against the sterling, an increase which slowed these last days after the turnaround of the British government which has abandoned its general taxes cut policy after having announced it some weeks before. The fall of the yen is spectacular: -23.3% when the Chinese currency, the Yuan has better resisted; the cause of the dollar appreciation is well identified, but the spreads between currencies would have important consequences for every country.

Central banks in all the major economies had adopted during the Covid-19 pandemic very accommodative policies. It was necessary to accompany the States action focused on the lessening of the consequences for the enterprises as for the household, of the activities stoppages resulting from the lockdowns decided to fight the pandemic. The very strong economic renewal occurred in 2021 after the sharp fall of activity in 2020, observed everywhere in the world except in China, has generated an inflation rebound. This one has been considered as temporary if not episodic and a large consensus has taken shape in order not to signing away the current recovery with the putting into place of restrictive monetary policies according to the respective mandates of each central bank. It was a mistake which has had as a consequence to make the current interventions more brutal.

The consequences of this mistake have been made worse with the invasion of Ukraine by Russia which has started a very strong rise of the prices of fossil fuels and of many agricultural commodities. The break of the industrial components supply chains provoked by the China very rigorous local lockdowns policy has constituted another factor which has, at last, leaded the central banks to start a turnaround in direction of restrictive policies in accordance to their mandates. The interest rates increase has, as an objective, to slow activity through making investments and household consumption financings more costly, which is supposed to contribute to solving the unbalances between supply and demand and so to stop the inflationist wave.

Among these institutions, the first one to act has been the Federal Reserve in Washington, which, with several 75 points increases of its basis rate, would send it to near 5% at the end of the year. This will be by far inferior to inflation, estimated, following the forecasts, around 8%. The European Central Bank has waited until September and is going to proceed to several increases but without that these ones reach the level observed in the U.S. The Japan central bank, because the country was much less affected by inflation has maintained its rates near zero when the Bank of England was increasing its ones both because the country had prices increase near 12% and in order to softening the pressures on the pound caused by a massive twin deficit, public and foreign trades, the country had in a political crisis environment. To the opposite, in China, where inflation remained around 2%, the Central Bank relaxed its financing conditions to support activity and to avoid that the crisis which was hurting the real estate sector put in danger the country financial stability. It has even, in order to supporting the Yuan on the currencies markets, sold a modest share of its very important dollar reserves.

These different economic and political environments explain the diverging evolutions of the parity against the dollar of their currencies. The level of a country interest rates and their expected trend have an essential influence on the currency exchange rate. Investors are looking after the best return and the issuing country, through rates increases, receives more subscriptions coming from foreigners which pushes the currency higher. This trend is amplified by the speculation, itself fueled by the messages delivered by the central banks about their coming decisions. It is the perception by the financial markets of the decisions of the central banks which guides the operator strategies and which explain the breadth of the spreads in the currencies rates evolution of each country we observe today.

The consequences on the world economy of the dollar rise are going to be very varied. The first risk concerns the emerging countries. A share of their public debts and of the bonds issued by local companies is frequently denominated in dollar. The reimbursements are going to be all the more costly and defaults cannot be diverted. It is what has happened at the end of the Nineties during the Asian crisis. The first country to be hurt had been Thailand and the contagion was quickly extended to its neighbors. The International Monetary Found is already on alert. That would increase the crisis climate in which the world economy is evolving but that will not affect directly and significantly the developed economies because the share in these countries in the world trade is not important enough to have effects on their activity.

In these ones, with the exception of the U.S., the dollar rise has an inflationist impact through making imported products more expensive with at the first place are all the commodities, including fossil fuels, whose prices are denominated in dollars. These negative consequences will not be compensated, in an environment of low growth and increasing protectionism, by the better competitiveness of the enterprises resulting from a more favorable exchange rate. These countries, with their central banks, both to slow the dollar rise and to reduce the internal inflationist tensions, are so going to adopt policies more and more restrictive with interest rates rising which will reduce the spread with the American ones. Until now, between inflation and recession, a strong consensus was in favor of inflation. This consensus is disappearing and the States, to the exception of Japan, will have to be obliged, without admitting it, to recognize that a recession, in 2023, is now unavoidable.

The situation in the U.S. is different. The level of the dollar does not constitute a determining factor in the country economic balances and its evolution has not impeached the country to endure a very important inflation. When a slowing was expected in September, prices year-on-year have progressed by 8.2%. in that environment, it would be unlikely that the Federal Reserve curbs its rates increase trend and these ones will probably reach 5% at the end of the year with a flat curve, medium and long-term maturities carrying rates sometimes inferior to the short-term rates, which is traditionally considered as a signal for a coming recession.

Only the taking into consideration by the exchanges markets that the 2023 year will have a negative growth rate in the developed countries is able to put an end to the dollar rapid rise and to reverse the trend. The inflationist pressures generated by the growing costs of the imports denominated in dollar will lessen. The phenomenon will combine itself with the diminution of the activity which will reduce the tensions on the production capacities and on the supply chains.

The worst is not sure and the financial crisis which could hurt markets in the case of even more brutal increases of the American currency is not the most likely hypothesis. But, to that, the idea of a recession must be accepted.     




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