The Strong Dollar and its Impact on the Global Economy
For the past two decades, the U.S. dollar had not been stronger than Euro. This, however, changed in July as the two currencies reached parity. For the first time since 2002, the U.S. Dollar and Euro had a 1:1 exchange rate. The dollar has continued to strengthen, as one American dollar is worth 0.98 Euros, as of September 11, 2022.
What made the dollar so strong? One of the most consequential reasons that boosted the value of the dollar is the U.S. Federal Reserve’s announcement to raise interest rates. Generally, higher interest rates lead to a stronger currency. In addition, turmoil in the global economy, including skyrocketing gas prices and the war in Ukraine, has led investors to secure haven assets like the U.S. dollar.
The strong dollar has been a blessing to some Americans who are traveling abroad, as it made their trip cheaper. For example, the strong dollar has allowed American tourists to enjoy discounts on hotels, car rentals, and other purchases in Europe.
On the other hand, the strong dollar has been difficult for other nations and multinational companies as it devalued currencies around the world. Besides the Euro, an overwhelming number of currencies around the world, including the Russian Ruble and Japanese Yen, have depreciated against the U.S. dollar.
Such depreciation is especially worrisome for developing countries as their economy depends highly on the global economy. More specifically, it has put a burden on emerging economies that need to repay debt in dollars and could further hinder their trade growth. For countries with depreciating currencies and where dollar debt represents a large portion of gross domestic product (GDP) such as Argentina, Turkey, or Sri Lanka, paying interest to creditors in dollars has become significantly difficult and burdensome.
Moreover, the strong dollar tends to shrink and depress global trade growth. The U.S. dollar is the dominant currency for invoicing and settling a majority of global trade transactions. Most of the developing countries are price-takers in the global trade market, which means that, if the dollar strengthens, firms in developing countries are likely to reduce their spending on crucial imports. Furthermore, foreign investors tend to pull the funds out of emerging markets and move the funds to safer investment destinations. This then will further shrink the domestic economies of developing countries.
Unfortunately, it is hard to predict how long the dollar will remain to be strong and when it will drop. Also, countries have few options to mitigate the issue for now. Nonetheless, countries should act to reinforce their fiscal position and engage in sustainable borrowing to prevent the next crisis and protect their economy.
Article Written by Young Shin Lim.
Sources:
N.Y. Times – The Dollar Is Extremely Strong, Pushing Down the World-July 16, 2022, available at https://www.nytimes.com/interactive/2022/07/16/business/strong-dollar.html
CNBC – U.S. travelers are getting bigger discounts in much of Europe amid favorable euro-dollar exchange rate- September 06, 2022, available at https://www.cnbc.com/2022/09/06/euro-dollar-exchange-rate-yields-steep-discount-for-americans.html
World Bank Blogs – Three ways a strong dollar impacts emerging markets-August 04, 2022, available at https://blogs.worldbank.org/voices/three-ways-strong-dollar-impacts-emerging-markets
Financial Times- A stronger dollar might hit emerging economies harder this cycle- June 28, 2022, available at https://www.ft.com/content/3e8737a0-b4c1-4e7c-b93f-f646e3c699dd
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