What will a Strong Dollar do to the World Economy?

Strong Dollar and inflation raging out of control, the US Central Bank (Federal Reserve) has stepped in to intervene. The only purpose of the US Federal Reserve (Fed) is to maintain stability in financial markets resulting in a number of interest rate hikes, with analysts expecting still more hikes to come.

Increasing interest rates has a number of side effects, one of which is an increasingly overpowered US dollar because people all around the world want to own USD. The dollar recently reached a 20-year high against other currencies.

As Fed continues to hike interest rates to try to slow down inflation, the dollar will continue to appreciate against other currencies. What are the effects likely to be, and how can we prepare?

Origins of the Dollar Standard

At the end of World War 2, leading economists from the US and UK gathered to plan the post-war economic order. There were two main camps– one was led by John Maynard Keynes, and argued that there should be an international currency, which he proposed to call “the Bancor.” The other camp, led by Americans, argued that the US dollar should be the international currency.

The Bretton Woods resort, where financial planners met at the end of World War 2 to plan the post-war financial system.

In the end, no one could agree about who would control an international currency, and the American camp had more political clout, so the US dollar became the world’s de facto currency. Many were concerned that the US could abuse its power as the issuer of the world reserve currency, but American officials assured everyone that the US dollar would be fully convertible to gold.

There were even efforts by President Kennedy to mint US coins in silver, but he was assassinated and the minting of silver coinage soon ended.

The government made good on the promise of converting Dollars to gold for approximately 16 years, and then Nixon announced the end of the gold conversion (standard). This allowed the creation of as many dollars as needed marking the beginning of unlimited monetary expansion and inflation which continues until today.

Throwing the World Under the Bus

The fears of those who opposed a world financial system dominated by the US dollar are now becoming a reality. The US is pursuing domestic policy goals, and harming the world economy in the process.

In order to lower inflation, the US is hiking interest rates. This is causing a flood of money into the US, propelling the dollar to historic highs. This has a number of negative effects on other countries.

• Everything getting more expensive. Imports in the US will get cheaper, but everyone else in the world will be paying more for internationally traded commodities like oil. Higher oil prices will mean higher production costs for everything, which will strain the budgets of governments and ordinary people around the world.
• Pressure on central banks worldwide to raise interest rates. With all the money flowing into dollars, central banks around the world will be under pressure to raise interest rates. Other countries will need to compete with the US for investors, but raising interest rates will greatly heighten the risk of a global recession.
• Defaults on debt internationally. The United States is one of the few countries to have fixed-rate mortgages. In most countries, loans are periodically readjusted to match interest rates. This means debt getting more expensive around the world. This could heighten the risk of “cascading defaults” like those that caused the 2007-08 financial crisis.

Many countries are discontent with the US dollar as the global reserve currency. The recent actions of the Fed will surely amplify that sentiment.

The debt trap

Debt levels are at historic highs around the world. At the same time, aging populations in wealthy countries mean that governments have more social services costs than ever before, with the bill growing.

Almost all of the world’s major economies are on unsustainable debt trajectories. Most countries are going to increase borrowing to deal with the crisis, and they’re going to be borrowing at higher interest rates. Since all currencies have no backing central bankers can create as much currency as politicians want, and they never intend to pay this debt back since it was created from nothing.

The last time commodity prices looked like they do now, there were revolutions in multiple countries that led to governments collapsing, and in some cases bloody civil wars that are still going on a decade later.

China and Russia are looking to break the US dollar-based international order, and the recent political, and moves by the Fed have greatly increased global support for their efforts.

Negative effects of a strong dollar inside the US

Although higher interest rates do mean lower inflation, there is a wide range of negative effects even within the US.

• Weaker US manufacturing. Another of the side effects of a strong dollar is a weaker US manufacturing sector. US manufacturing has seen a resurgence in recent years, with more international demand for American equipment and machinery. A stronger dollar makes US exports more expensive. This will cause a backlash, especially with blue-collar workers, many of whom lean toward the GOP and are Trump supporters.
• Lower corporate revenue. Higher interest rates mean fewer loans, which means less overall economic activity. Approximately 40% of corporate revenue in the US comes from international customers, and that income will be hit hard by a stronger dollar.
• Less tax revenue and tighter fiscal policy. Lower corporate revenue means less tax revenue, which means less available funds for government programs. Especially with the US’s support for Ukraine, this means there will be more pressure on social programs and entitlements. The government has no way out of this. Either they can reduce spending, leading to political instability, or borrow more, further increasing the cost of debt servicing and cutting creditworthiness in the future.
• Lower real estate prices. Higher interest rates mean fewer home buyers, and less demand means lower real estate prices. Likewise, a recession means higher demand for rentals. Mortgage applications have fallen off a cliff in September to historic lows.

Normally, lower values in stocks and real estate would mean that investors would turn to bonds. However, as the recent bond market crisis in the UK showed, this time may be different.

The end of the reign of the dollar?

So this policy has a whole lot of potentially dangerous side effects. Some might argue that all this is needed to push down inflation. But lower inflation rates in the US don’t mean that inflation is going away globally.

A stronger dollar means cheaper imports for the US which can help to keep consumer goods inside the US cheap, but eventually, there is going to be a reckoning. So what happens when all the countries suffering under selfish US monetary policy finally say they’ve had enough?

Price is ultimately determined by supply and demand. Everyone around the world has to buy large amounts of dollars to buy oil and many other important goods. Russia is already working to undermine this system by selling oil and gas for rubles, and China is looking to offer an alternate, potentially gold-backed currency to compete with– and potentially replace– the US dollar.

If more countries start moving away from using dollars (which seems likely, given the Fed’s recent decisions), a huge amount of demand for dollars will disappear. That will mean less demand and more propping up of the dollar, leading to more inflation.

The more the Fed tries to raise interest rates to get out of this trap, the worse the recession will get, and the more angry the rest of the world will get, increasing the pressure to end the dollar’s world reserve currency status.

What can we do about it?

China, as the world’s biggest exporter, has a lot of leverage to make people use a new currency. If China starts to demand everyone pay for Chinese goods in their new digital yuan, many countries will be forced to do so. This could generate a lot of demand which would prop up China’s currency.

As bad as having the world’s reserve currency run by the federal reserve may be, most sane people would agree that having the world’s reserve currency run by the Chinese Communist Party would be worse.

We need to get the power of government away from our money as much as possible. When we use their currency, we are increasing its power. This is why we should make our best effort to avoid using currencies run by tyrannical and/or irresponsible governments, and use politically neutral, sound money instead.

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