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- The world’s central banks are scrambling to keep up with the Federal Reserve’s aggressive rate hikes.
- A strong dollar puts others at a disadvantage: fight inflation and growth, or allow prices to continue to rise.
- Countries are largely opting for the former, and a widespread slowdown could exacerbate America’s own decline.
As the US dollar strengthens, this comes at the expense of other currencies around the world.
And as the Federal Reserve hikes historically large interest rates to fight inflation, the dollar is fully strengthened in mid-2022. The rally has put central banks around the world in a race to see who can raise interest rates – and the value of their currencies – to move forward quickly.
As it stands now, the Fed still commands sound leadership – a designation that lends itself to more policy moves.
And while the ongoing “reverse currency war” may sound like good news for the U.S., the nature of the modern global economy is that external slowdowns can hurt domestically.
Today, the Federation leaves a difficult choice. Ending the hiking cycle would ease the pressure on other countries, but the US could fall into persistently high inflation.
On the other hand, going ahead with austerity would help curb rising inflation in the states, but would further put the brakes on economic growth. This includes the risk of widespread layoffs, weak wage growth and reduced investment rates in the US.
American policy is what the rest of the world is scrambling to keep up with.
On September 21, Fed Chairman Jerome Powell reiterated that the central bank will not stop raising rates “until the job is done”. With the potential for jumbo growth, major economies such as the UK, Japan and China are vulnerable to a prolonged recession. As their currencies weaken against the dollar, those countries must accelerate their inflation and risk recession or allow the dollar to strengthen further and devalue their own currencies.
As a result, more than 80 central banks around the world are following the Fed’s lead. Continuing the consolidation plan launched earlier this year, they are moving aggressively to moderate their own unique inflation.
Yet there is little coordination among policy makers. Instead of officials working in concert to tame global inflation, central banks are rushing to move their own money as fast as possible.
In the United Kingdom, the new Conservative government came up with a tax cut plan intended to weaken the economy. But the proposal drew reprimands from the IMF for clashing violently with the economic consensus – and hampered the Bank of England’s rate hike efforts.
The pound fell to a low against the dollar – and British government bonds – as investors fear a ballooning deficit.
This delayed the Bank of England’s plans to start buying government bonds and reduce its balance sheet in an effort to stabilize the debt market. But the bank’s buying program will pump more money into the UK economy at a time when inflation is in the red at 9.9 per cent.
The alternative is no more appetizing. Failure to buy the pound and the recent sell-off could open the door to a steep fall for the currency. That would significantly raise prices for imports in a country that already buys nearly half of its food and most of its energy from other economies.
As prices rise across the UK, the country moves closer to a deep recession. In high inflation households tend to reduce their demand in order to protect their money. Poor spending leads to lower incomes, which in turn leads to layoffs and triggers a catastrophic recession.
Other central banks are pegging their currencies to the dollar and taking stronger action to curb import spending. With the yen trading near a 24-year low, the Bank of Japan intervened earlier this month to ditch the dollar and buy the local currency, the first time Tokyo has intervened directly in the currency market since 1998.
Japan, which has been struggling with inflation rather than inflation, is not seeing the same rate of inflation as countries like the US and the UK.
But there are signs that pressures are beginning to build. According to Deloitte, import volumes increased by a third compared to last year. A depreciating yen makes those imports more expensive, driving up inflation.
The Bank of Japan has indicated that it will use monetary policy to increase the yen, if it threatens price stability, but the increase in interest rates required to do so may slow growth.
The People’s Bank of China is working to strengthen the renminbi, which is currently in its worst year since 1994. He told the major state-owned banks to get ready to dump their dollar holdings as they unloaded the offshore yuan.
But Chinese banks will be forced to strengthen their balance sheets at a time when economic growth is slowing. Beijing’s ‘zero-Covid’ approach to pandemic lockdowns has led to a sharp drop in business activity, and the government recently cut its annual GDP forecast to 2.8% – more than half of its 5.5% target.
Just as Jerome Powell was not responsible for the UK Conservative Party’s tax cut proposals, the Fed did not force China to continue locking up its people. But his aggressive rate hikes are fueling global economic uncertainty as other central banks seek to hedge their currencies against a rising dollar.
“Recently tighter monetary and fiscal policies will help reduce inflation,” World Bank Acting Vice President for Equitable Growth, Finance and Institutions Ayhan Kose said in a recent report. But because they are so similar across countries, they can compound on tightening financial conditions and slowing global growth.”
While the US is leading the way for now, its dominance could quickly backfire.
The Fed is ineffective in this central bank game of chicken. The forecasts published on September 21 suggest that policymakers will raise interest rates by another 1.25 percent before the end of the year and continue to raise them until 2023.
Powell hinted that the Fed would err on the side of over-tightening, meaning that it would prefer to let rates fall rather than go uncorrected. In his press conference on September 21, the chairman reiterated the need for a period of low growth and high unemployment to balance the economy and moderate inflation. And Powell, in his annual speech in Jackson Hole, Wyoming, emphasized the value of aggressively fighting inflation to avoid a worse recession later.
“History shows that as high inflation takes root in wages and prices, the cost of labor can be delayed to bring down inflation,” he said.
But Powell seems to be taking a “soft-ish landing” scenario — where rising prices lead to only a mild recession — for what it is. If other central banks are forced to move faster to keep pace with the dollar’s appreciation, his hawkish remarks could fuel global growth failures that will come back to bite America.
The United States relies on imports to maintain a steady supply of goods like food, crude oil and auto parts — and the prices of those goods are directly linked to the performance of other global economies.
Let’s take China as an example. Manufacturing and industrial activity could fall if Beijing pegs the yuan against the dollar, sending China’s economy into recession. That means China produces the same products it exports to the U.S. — products like aluminum, glass and wood.
As supplies of the goods fall, import prices may rise. U.S. importers are left with a choice between passing those higher costs on to consumers or seeing their profit margins take a hit — either way, contributing to a worse recession.
What started as an effort to control US inflation suddenly turned into a global recession.
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