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Why a strong dollar is bad for the Global economy – By Shan Saeed, Chief Economic Consultant

DO WE NEED ANOTHER PLAZA ACCORD OF 1985 ????

A possible revaluation.

The US dollar has moved higher after Nov 8th 2016, following Donald Trump’s election win. The world’s reserve currency is showing its strength finally. After the elections, the dollar had one of its sharpest rises ever against a basket of rich-country peers. It is now 40% above its lows in Aug -Sept 2011. It has strengthened relative to the emerging-market (EM) currencies, too. Why the surge in the dollar, OR can I call it market exuberance?

The market players believe that Trump will cut taxes and spend more public funds in fixing America’s crumbling infrastructure. A big fiscal boost would lead the Federal Reserve to raise interest rates at a faster rate to check inflation. Are we seeing a replica of 1980 when interest rates touched 20% during Reagan’s era? The strong dollar is cheered in Tokyo, Chicago, New York and Frankfurt; however it’s not welcomed in the emerging markets, the driver of the global economy.

There are 4 solid reasons:

  1. A strong dollar creates lot of uncertainty in the financial system of the Emerging market. This sends a tingle to the investors in EMs who are not prepared for the surging dollar.
  2. A strong dollar creates higher risk in the equity and bond markets. Markets believe that higher interest rates and a strong dollar will butcher the equity and bond investors. It is very TRUE.
  3. A stronger dollar puts pressure in EMs to raise interest rates in panic without giving them time to analyze the situation. The depreciating EMs currencies bring inflation and lower the purchasing power and living standards of people in the emerging market countries.
  4. A stronger dollar leads to credit conditions. Lots of companies in EMs have borrowed heavily in US dollars. When the dollar is weak, they borrow freely without taking risk of a higher dollar into account. A strengthening dollar causes a general tightening of credit in emerging markets.

SO, WHAT WILL HAPPEN NEXT?

If the dollar stays strong, we might be headed for protectionist policies by various countries. QE is a modern form of protectionism. Policy makers are now talking about Plaza accord, an agreement in 1985 between America, Japan, Britain, France and West Germany to push the dollar down again, which is looking very likely. The Japanese yen in September 1985 went from 242 Yen/ USD [Yen per dollar] to 153 in 1986, a doubling in value for the yen. By 1988, USD/JPY exchange rate was 120. The same thing happened with the German Deutsch mark, French Franc and British pound. 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. Do you need currency revaluation in the next 3-6 months when the blood gets thicker? Let’s see once the turmoil arrives.

NOTES FROM CHEAT SHEET.

  • Putin calls Trump a clever man due to his straight-forward and ruthless approach. Nobody can mess with Donald Trump.
  • Janet Yellen did not increase the interest rates on Dec 14 2016 as the Yuan has gone down by 10 % in the last 12 to 18 months; Pound went down by 12 % and Euro down 5.5%.
  • Investors are suddenly looking to Japan. Why Japan has become from underweight [sell] to overweight [buy] in equities market.

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