Novus ordo seclorum
America’s relative clout as a trading power has been in steady decline: the number of countries for which it is the biggest export market dropped from 44 in 1994 to 32 two decades later. But the dollar’s supremacy as a means of exchange and a store of value remains unchallenged. Some aspects of the greenback’s power are clear to see. By one estimate in 2014 a de facto dollar zone, comprising America and countries whose currencies move in line with the greenback, encompassed perhaps 60% of the world’s population and 60% of its GDP.
Other elements are less visible. The amount of dollar financing that takes place beyond America’s shores has surged in recent years. As emerging markets grow richer and hungrier for finance, so does their demand for dollars. Since the financial crisis, low interest rates in America have led pension funds to look for decent yields elsewhere. They have rushed to buy dollar-denominated bonds issued in unlikely places ... By last year this kind of dollar debt amounted to almost $10trn, a third of it in emerging markets, according to the Bank for International Settlements, a forum for central bankers.
When the dollar rises, so does the cost of servicing those debts. But the pain caused by a stronger greenback stretches well beyond its direct effect on dollar borrowers. That is because cheap offshore borrowing has in many cases caused an increased supply of local credit. Capital inflows push up local asset prices, encouraging further borrowing...
A strengthening dollar sends this cycle into reverse. As the greenback rises, borrowers husband cash to service the increasing cost of their own debts. As capital flows out, asset prices fall. The upshot is that credit conditions in lots of places outside America are bound ever more tightly to the fortunes of the dollar. It is no coincidence that some of the biggest losers against the dollar recently have been currencies in countries, such as Brazil, Chile and Turkey, with lots of dollar debts.
If the dollar stays strong, might protectionist pressure be defused by co-ordinated international action? Nascent talk of a new pact to rival the Plaza Accord, an agreement in 1985 between America, Japan, Britain, France and West Germany to push the dollar down again, looks misplaced. Japan and Europe are battling low inflation and are none too keen on stronger currencies, let alone on the tighter monetary policies that would be needed to secure them.
Stockmarkets in America have rallied on the prospect of stronger growth. They are being too cavalier. The global economy is weak and the dollar’s muscle will enfeeble it further.
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