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  • Writer's pictureElaine Hua

Strong Dollar in the time of Crisis

by Elaine Hua on 17/09/22

Image source: Wix Media


Introduction:

As inflation is soaring in the UK, the US dollar stayed strong and reached its highest level since the 2000s. For the first time in two decades, the dollar is now at par with the euro. The Japanese yen and Chinese yuan exchange rate against the dollar has also decreased rapidly. This blog will analyze the reason behind the recent currency fluctuation, why the dollar is able to stay strong during a time of crisis, and its implications on businesses as well as consumers from respective countries.


Understanding the dollar remains strong against other currencies in a time of crisis

  • Reason 1: The US Federal Reserve has now raised interest rates from 0.75% to 2.25%. By increasing the interest rate, the government endeavors to discourage businesses from borrowing money to decrease economic activity; this deters inflation and preserves the value of the currency against other currencies.

  • Reason 2: This is perhaps the most important reason according to many experts. The US dollar exchange rates always manage to strengthen in times of crisis, whether it is the 2008 global financial crisis (aka. Subprime mortgage crisis), the 1956 Suez Crisis, or the COVID pandemic. Investors generally see the US dollar as a safe haven to put their money in when there’s a crisis owing to its strong national security and capital market.

  • Reason 3: The disruption of the energy market would mean that investor’s confidence in the US, which is a net energy exporter, was boosted, while on the other hand, their confidence in the British pound and Euro was greatly hindered by the uncertainty of if these economies can overcome the energy crisis this winter.


Impact

On US economies

  • A stronger dollar helps curb inflation

  • To US civilians, the cost of overseas travel decreases, as does the price of imported goods. While for other countries, especially emerging markets, it would mean the opposite.

On other economies

  • There will be increasing strains on countries that are in debt with loans denominated in dollars. This was particularly the case for emerging markets that previously borrowed US dollars from the global market for their infrastructure projects or imports, which are now trading their debt at distressed levels, the most prominent example is Zambia and Sri Lanka. When those countries issue sovereign bonds in US dollars, they promise the bond buyer from the global market good rates in return, due by a certain date. When the US dollar strengthens rapidly, investors doubt whether the countries are still capable of paying the bond in the US dollar back. Concerning the risk of default, some investors who previously purchased those sovereign bonds are now reselling the bond at a significantly discounted price. However, those countries in debt still have the urgent need to borrow more money in order to sustain their spending, to do that, they could only issue their sovereign bond at a much lower price while promising the same rates or promising better rates, this is known as trading the debt at a distressed level. This could lead to serious repercussions as defaulting on the sovereign bond would mean that those countries lose their long-term credibility and investors will be cautious not to purchase future bonds from them.

  • Zambia, and Sri Lanka, among others, have defaulted on dollar-denominated loans as they are faced with the heavy costs of infrastructure, falling export earnings, and not enough US dollars to pay the imported goods.

  • Bloomberg estimates that approximatley10% of dollar-denominated debt is at a high risk of default.

On businesses

  • Some multinational American businesses, such as Johnson&Johnson, complained that the rising dollar has affected their earnings because the profits made overseas depreciated in value when being exchanged back into dollars. In addition, because the dollar is now more expensive, their products are less competitive overseas.

  • To businesses in other countries, it would mean fewer profits for companies that invest in real estate, or businesses that survive on imported materials. For example, in Japan, many restaurant owners complain that they were ‘out-bought’ on the fish stock market by other countries as the yen has depreciated. On the other hand, exporting businesses that sell their products to the US will profit as the US dollar strengthens.


The future development

While currencies are hard to predict, there would be two ways where US dollar stopped strengthening :

  1. If the conflict in Ukraine is resolved. With the war ending, it will save the European economy from the energy crisis and boost investors' confidence in investing in the EU and other currencies.

  2. If the US goes into a recession. Some experts predict that constantly increasing the interest rate and increasing the cost of borrowing may over-cool the economy and lead to a recession next year. As a result, US assets would seem less attractive and the price of the dollar will drop down.


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