“The truth is, it feels like the recession is already here,” Bloomberg magazine headlined this week. “Americans are tired of inflation,” the Wall Street Journal also stated. Americans are really not happy. According to a poll (Harvard-Harris) published last weekend, more than two-thirds of them are dissatisfied with the way President Biden handles the economy, and 64% feel their personal financial situation is getting worse. These are extremely bad figures for the American president.
True, despite the bad mood with which she came to this week’s Independence Day celebrations, America is probably not currently in recession. But it is estimated that she may run into him next year. These estimates raise the question: If America is in such a bad situation, how is it possible that the dollar is only strengthening against other currencies? The answer is that everything is relative. As the renowned economist and investor Dr. Muhammad al-Arian put it this week: Your situation is good if you have the cleanest shirt in the world economy. And America has the least dirty shirt right now.
According to Al Arian, there are three main reasons, according to an article published earlier this year in the Financial Times, that the US currency is so strong: the expectation that the Federal Reserve will raise interest rates more aggressively than other central banks (a process in progress, making the US currency more attractive Compared to other currencies), the fact that the American economy itself, despite the atmosphere of mourning, is still in good shape relative to other economies, and finally, the fact that US markets are still perceived as a safe haven.
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For example, in a reality where the European economy suffers from energy shortages and is faltering on the brink of recession, the European Central Bank has not yet begun to raise interest rates, and as the shadow of a debt crisis hovers over southern Europe – it is understandable why the dollar strengthens against the euro.
Scenario: Small fires everywhere
The strengthening of the dollar against other currencies is not just a symptom of the strength of the US economy, of the determination of the Federal Reserve, or of the slowness of the European Central Bank. It may also be a problem for the rest of the world, which is a novelty. If in the previous decade, the countries of the world wanted to weaken their currency, and thus help their exporters, at the expense of other countries, now the situation has been reversed. Instead of a currency war, we are entering a period of ‘reverse currency war’.
“As part of efforts to bring down inflation, raising interest rates plays an important role,” economist Prof. Jeffrey Frenkel of Harvard, a renowned expert on international economics, explained in an interview with Globes. “Often one of the side effects, and this is what has happened in the last year, is that raising interest rates makes your currency more attractive, capital-intensive, and causes currency appreciation.”
Frenkel explained that the strengthening of the dollar is problematic for countries suffering from inflation. A stronger dollar means an increase in the prices of imported products. And indeed, a quick browse through the headlines around the world raises a host of complaints about imported inflation, from India to Switzerland. And in trying to deal with this imported inflation, a dynamic may develop that Frenkel prefers to describe using the term ‘competitive appreciation’, in which countries raise interest rates to try to support their exchange rate.
The strengthening of the dollar, according to al-Arian, is a special problem for developing economies, which not only have to pay more for goods and products priced in dollars, but also often face dollar-denominated debts – and the strengthening of the dollar, along with rising interest rates, .
A debt crisis in developing economies is, of course, first and foremost a crisis for them, and could cause them severe economic damage. But al-Arian, a former deputy chairman of the International Monetary Fund, explains that it is not just the troubles of others. Which will increase volatility in the markets and trickle back to the advanced economies.
The advantage will be for those who move faster
Those who started talking about ‘reverse currency war’, back in February this year, are the analysts of Goldman Sachs. In the middle of the previous decade, they recall, the Federal Reserve began to raise interest rates, without central banks in the other major advanced economies joining it. But now the situation is different.
The yen is falling against the dollar, but Japan insists on not changing policy
The conduct of the Central Bank of Japan is a testament to the change in priorities, in which they emphasized the local currency in the previous decade. Most central banks around the world are retreating from expansionary monetary policy, with the aim of curbing inflation, while countries that have chosen not to align with US interest rates are suffering from capital flight and currency devaluation. Japan is an extreme case where the central bank (BOJ) continues to insist on monetary policy Ultra-expansion without fear of inflation The Tokyo line has led to consequences such as the fall of the yen to a 24-year low.
In Japan, they choose to help with zero credit terms where the central bank continues to buy government bonds at record highs, in order to maintain the yield ceiling of government bonds at the level of 0.25%. Not to act against the trend in the world, under the assumption that inflation will eventually get there as well.
The situation invites speculators to gamble against the Bank of Japan’s policy, as the weakening of the yen increases the cost of imports, which contributes to inflationary pressures – and ostensibly makes it difficult for the Bank of Japan to resist, and not interfere with the continuation of huge money printing. In Tokyo, however, it is believed that all inflation comes from the supply side, and detached from what is happening in the world, it is not expected to climb.
In early June, the Bank of Japan renewed its commitment to buy government bonds as needed, to keep credit costs low. That is, when the yields to maturity of the bonds exceed 0.25% – the bank will purchase any quantity, despite the effects on the currency.
Guy Ben Simon
This time the starting point is relatively high inflation, which means that “central banks will have less tolerance for a large devaluation of their currency against the dollar when the Fed raises interest rates, given that currency weakness usually causes inflation to be imported from abroad.” Of Fed policies to other advanced economies: When America raises interest rates, the rest are forced to follow suit, creating a dynamic in which central banks drag each other up to raise interest rates more than they planned.
In such a situation, Goldman analysts add, we may see an advantage for those who move faster, and manage to prevent a strengthening of the currency that will contribute to inflation. Here, too, analysts find a contrast to the period between 2015 and 2018, during which the central banks tried to delay as much as possible with the interest rate hike, and those who actually acted quickly paid a price for it.
Echoes of this dynamic, by the way, could be heard at the Bank of Israel’s press conference this week, where Governor Amir Yaron also referred to imported inflation, emphasizing that the Bank of Israel began tightening monetary policy as early as last year. In response to a Globes question, Prof. Yaron preferred not to comment on “one exchange rate or another,” but stated that the devaluation of the shekel “certainly contributes to the inflationary side,” leaving room for action: “The Monetary Committee has a wide toolbox. What a tool. “
But this dynamic, as mentioned, is global, and employs for example the central bankers in Europe. The one who explicitly referred to it was Catherine Mann, a member of the Bank of England’s Monetary Committee, in a speech dedicated to the impact of the US interest rate hike on the UK, which she delivered two weeks ago. More emphatically: “that you reduce the risk that local inflation that has already been assimilated will be strengthened by imported inflation through a devaluation of the pound exchange rate.”
Will the war turn out to be a transient conflict?
So will the dollar continue to strengthen? who knows. According to an analysis published earlier this year by Goldman Sachs economists, for example, the strengthening of the dollar should be limited in the end – because the other central banks will act this time to moderate their currency weakening. So far, as mentioned, the dollar continues to strengthen. But according to Goldman, in recent months we have entered the next stage in the reverse currency war – and for example, statements on the subject of senior executives at the European Central Bank, and the line led by the Swiss central bank, which did raise interest rates unexpectedly last month.
The battle for the ruble
The Russian ruble appears to have been traveling inside a roller coaster in recent months. The invasion of Ukraine in late February and the steps taken by the central bank to prevent its collapse shocked it up and down with lows and highs that had not been seen for years.
The two main reasons for the jump in currency value are the jump in global energy prices, and the aggressive steps taken by the Russian central bank.
Immediately after the outbreak of the war, the ruble plunged by tens of percent to a low of less than one US cent (139 rubles per dollar). Within three months, however, the Russian currency soared to a seven-year high and stabilized at about 52 rubles to the dollar.
The reaction to the collapse of the ruble by 30% near the invasion of Ukraine was a jump in interest rates from 9.5% to 20%. The central bank has also increased its supervision of capital, in order to prevent a collapse of the economy. Among other things, he limited the amount of money that could be withdrawn from the banks, banned the exchange of rubles in foreign currencies and prevented the issuance of foreign capital from the countries.
Also, Russian companies were instructed to sell 80% of the proceeds in foreign currency to strengthen the ruble. At the same time, energy prices have led Russia to make tens of billions of dollars a month from gas and oil exports.
The central bank was “pressed” by the jump in currency
The ruble jumped so high that the central bank was “pressed” and changed direction in order to weaken it. The bank reduced the interest rate, in three different beats, to only 11% – only 1.5% more than before the war.
After Russia’s first insolvency in a century, the ruble could have been expected to suffer, but Russia is facing the opposite problem: the jump of the ruble has made the Russian currency the best performing against the dollar, according to an analysis by the Dow Jones company. To the displeasure of Moscow, this situation diminished the value of oil and gas revenues that are priced worldwide in dollars.
In another attempt to curb the rise of the ruble, Russia announced the purchase of currencies of “friendly” countries in order to influence the exchange rate against the dollar and the euro. And what does the near future hold for Rubel? It is not known, but it is clear that he will be affected by the war in Ukraine.
Roi Barak
But there are those who predict that the current episode will turn out to be transient for another reason. Bloomberg commentator Robert Burgess, for example, looks back 20 years to an era in which the United States suffered from a chronic current account deficit and needed a flow of capital from the rest of the world to cover it – leading to a weakening of the dollar.
Burgess, who like others also stressed the weakening of the dollar’s status as a “global reserve currency,” points out that the US current account has also deteriorated since the outbreak, and therefore predicts that if anything, the dollar will weaken in the future. That the reverse currency war would turn out to be a transient conflict.