The British pound, like most other major currencies other than the dollar, has been under siege throughout 2022. And the situation worsened dramatically last week when Britain’s new Prime Minister, Liz Truss, unveiled a spending plan to boost economic growth.
Investors fear the plan – which will require £45bn of new debt and includes the UK’s biggest tax cuts in 50 years – will only serve to exacerbate inflation and undo the work of the Bank of England’s rate hikes close.
Despite a negative market reaction to the new fiscal measures last week, Britain’s Chancellor of the Exchequer, Kwasi Kwarteng, said over the weekend that “more is to come” in tax cuts, sending the pound to a record low against the US dollar on Monday.
The once-dominant sterling has fallen more than 21% against the dollar this year, and it’s not the only foreign currency to struggle. The Japanese yen is also down about 20% year-on-year against the dollar, while the euro and Thai baht are both down more than 15%.
The dollar will rule 2022 amid the Federal Reserve’s aggressive rate hikes, Europe’s energy crisis and China’s COVID lockdowns.
As wealth As previously reported, investors looking to protect their capital during these trying economic times are looking to the greenback as a safe haven as the US economy is “the cleanest dirty shirt,” according to Eric Leve, chief investment officer at asset management firm Bailard.
However, economists warn that the dollar’s strength could also be a nightmare for the global economy.
“What is clear is that we have this inexorable rise in yields, this inexorable appreciation of the dollar. Both are bad news for businesses and the economy,” Mohamed El-Erian, the president of Queens’ College at Cambridge University, told CNBC on Monday.
Echoing Leve’s comments, El-Erian explained that with the “fires burning” in all developing countries – and now even countries like Britain – the dollar is the currency of last resort for investors.
“The reason why this latest surge in the dollar is happening is that we are the safe haven and as a result our currency is strengthening,” he said.
The Strong Dollar: A Global Wrecking Ball
This isn’t the first time El-Erian has warned of the potentially catastrophic effects of a strengthening US dollar.
In a Sept. 6 Washington Post op-ed, El-Erian explained that a strong dollar can be an “ambiguous blessing.” On the one hand, the greenback’s strength is helping to reduce US inflation, but at the same time, a sustained strong dollar can bankrupt developing countries as their dollar-denominated debt costs skyrocket.
This is exactly what happened in the Latin American debt crisis of the 1980s. Developing countries in Central and South America amassed billions in low-interest dollar loans in the 1970s. Then, starting in 1982, when the US drastically raised interest rates to fight inflation, the cost of debt skyrocketed, 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 of emerging markets.
“The longer and higher the dollar rises above the rest, the greater the risk of prolonged global stagflation, debt problems in developing countries, more restrictions on the free movement of goods across borders, greater political turmoil in fragile economies, and greater geopolitical conflict,” he wrote in his comment on The Washing Post.
On Monday, El-Erian also noted that the US dollar’s recent strength is contributing to just three major paradigm shifts that have led to an “uncomfortably high probability” of a global recession.
The top economist broke down those shifts in his latest Bloomberg commentary over the weekend.
First, he noted that central banks around the world have shifted from supportive to restrictive policies in virtually unison to counter inflation. Second, he explained that global economic growth is “slowing significantly” as the world’s three major economies, the US, EU and China, all continue to lose momentum.
Finally, he said that the globalization process, which has helped fuel a deflationary trend worldwide for the past two decades or more, is now easing due to “persistent geopolitical tensions”.
In his interview with CNBC on Monday, the top economist explained that these paradigm shifts have only been exacerbated by government policies, urging policymakers to stop increasing volatility and hinting at Britain’s new tax cut and spending plan .
“It’s not just about the big paradigm shifts,” El-Erian said. “The point here is that governments and central banks are sources of volatility rather than suppressors of volatility. They add to volatility, it’s particularly evident in the UK government but also in the US at the Fed… it’s quite a mess in some of these markets and these are the main markets for the global economy.”
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