The British pound, like most major currencies other than the dollar, has been under siege throughout 2022. And the situation worsened dramatically last week, when new UK Prime Minister Liz Truss unveiled a plan of spending to boost economic growth.
Investors fear the plan, which will require £45bn of new debt and includes the biggest tax cuts seen in Britain for 50 years, will only serve to exacerbate inflation, undo the work of rate rises of interest from the Bank of England.
Despite last week’s negative market reaction to the new tax measures, UK Chancellor of the Exchequer Kwasi Kwarteng said over the weekend that there would be “more to come” on the tax cuts, making the The pound fell to a record low against the US dollar on Monday. .
The once-dominant pound sterling is now down more than 21% this year against the dollar, and it’s not the only foreign currency struggling. The Japanese yen is also down about 20% against the dollar, while the euro and Thai baht are down more than 15%.
The dollar has dominated 2022 amid aggressive interest rate hikes by the Federal Reserve, Europe’s energy crisis and China’s COVID lockdowns.
How the fortune As previously reported, investors looking to protect their capital in these tough economic times see the greenback as a safe haven because the U.S. economy is “the cleanest dirty shirt,” according to Eric Leve, director of ‘investments of the asset management company Bailard.
But economists warn that the strength of the dollar can also be a nightmare for the global economy.
“What is clear is that we have this relentless rise in yields, this relentless appreciation of the dollar. Both are bad news for businesses and bad news for the economy,” Mohamed El-Erian, president of the Queens, told CNBC on Monday ‘ College of the University of Cambridge.
Echoing Leve’s comments, El-Erian explained that with “fires burning” across the developing world, and now even in places like the UK, the dollar is the currency of last resort for to the investors.
“The reason why this last stage of the dollar is happening is because we are the safe haven and a consequence of that is that our currency gets stronger,” he said.
The Strong Dollar: A Global Wrecking Ball
This is not the first time El-Erian has warned about the potentially disastrous implications of a rising US dollar.
In a Sept. 6 Washington Post op-ed, El-Erian explained that a strong dollar can be a “mixed blessing.” On the one hand, the strength of the greenback helps reduce US inflation, but at the same time, when the dollar remains consistently strong, it can bankrupt developing nations as the costs of their dollar-denominated debt increase
This is exactly what happened in the Latin American debt crisis of the 1980s. Developing nations in Central and South America amassed billions in dollar-denominated loans at low interest rates in the 1970s. Then, when the US dramatically raised interest rates to fight the inflation starting in 1982, debt costs soared, triggering a crisis that plunged Latin America into a “lost decade,” according to the Federal Reserve.
And El-Erian warns that a strong dollar can also have a number of devastating effects outside emerging market economies.
“The longer and higher the dollar soars above the rest, the greater the risk of more prolonged global stagflation, debt problems in the developing world, more restrictions on the free flow of goods across borders , greater political turmoil in fragile economies and greater geopolitical conflict,” he wrote in his Washing Post op-ed.
On Monday, El-Erian also noted that the recent strength of the US dollar only adds to three key paradigm shifts that have created an “uncomfortably high probability” of a global recession.
The top economist broke down these changes in his latest Bloomberg article over the weekend.
First, he noted that central banks around the world have moved from supportive to restrictive policies virtually in unison to counter inflation. Second, he explained that global economic growth is “slowing significantly” as the world’s three largest economies, the US, the EU and China, continue to lose momentum.
And finally, he said the process of globalization that helped drive a deflationary trend around the world over the past two decades is fading because of “persistent geopolitical tensions.”
In his interview with CNBC on Monday, the top economist explained that these paradigm shifts have only been made worse by government policies and called on policymakers to stop increasing volatility, hinting at the new plan to reduce UK tax and spending.
“It’s not just about the big paradigm shifts,” El-Erian said. “It’s about governments and central banks being sources of volatility rather than suppressors of volatility. They add to volatility, that’s particularly clear with the government in the UK, but also in the US with the Fed… it’s a major disaster in some of these markets and these are major markets for the global economy.”
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