In the world of foreign trade, there is a typical reflex response: a strong dollar is good. If the dollar increases in value, it’s Christmas in export economies like Japan, China, and Germany. In fact, one can argue that the more expensive the imports of raw materials become on a U.S. dollar basis, the more the advantage of trading is negated. However, it appears that among major import goods, oil, and gas currently are favorably positioned: prices are falling faster than the U.S. dollar is rising against the euro.
These are wonderful times for export enterprises, their profits, and, not least, stock prices? But wait! A strong dollar can indirectly hurt exports and can even cause real pain for the entirety of Western economies.
A Stronger Dollar Can Really Hurt
Some 60 percent of global sovereign debt is recorded in U.S. dollars to avoid the otherwise payable risk premium yielded by issuing in local currencies. Meanwhile, emerging markets sit on almost $3 billion in loans. Following the collapse of the U.S. housing bubble and due to apocalyptic U.S. debt — state debt at $18 trillion and total debt nearing $60 trillion — as well as the maturation of China as a competing superpower, many local investors were of the opinion that U.S. currency would fall considerably.
The price that the foreign debtor pays for its loans in dollars is high. Brazil alone has to spend 20 percent more than in 2013 for its foreign debt in terms of real depreciation, let alone Russia. If the devaluation of the ruble continues, interest expenditures in Russia will increase by 50 percent.
Double Trouble for Oil and Gas Producing Countries
The dollar increase holds true to the core for oil and gas producing countries. Previously these countries could effortlessly afford external loans via abundant commodity revenues. Now this revenue stream has become a revenue trickle. And energy producing countries are now trying to pay for the growth in volume of the required sociopolitical wealth transfers to prop up their population. They thereby risk further decreases in energy prices and hence a more sustainable diet for government revenue. Meanwhile, OPEC, the former stallion of energy economies, has become a timid gelding, and prices can no longer be determined due to alternative methods for oil and gas production.
A Strong Dollar Has Always Been a Nail in the Coffin for Emerging Markets
In the past, appreciation of the U.S. dollar was often associated with crises in emerging markets. This took development of their equity markets into account: the so-called Asian Tigers had little happiness pegged to a strong dollar between 1995 and 2002. In contrast, the weakness of the dollar from 2002 to 2008 did the emerging markets some real good. The subsequent collapse of the housing market reeled the dollar back in, and the goose of Asia and South America’s equity markets was cooked. And since mid-2014, the dollar has been refreshed and is dynamic. Incidentally, almost one-fifth of all companies in the MSCI Emerging Markets Index comprise oil and gas exporting countries.
In contrast to previous downturns, a new crisis in emerging markets would not be limited regionally. There would be global collateral damage. Emerging markets are globally and systematically important to the financial sector. Should these world economic engines which are facing currency indebtedness and which are lacking compensation for energy commodities run out of steam, so to speak, then no country would suffer from loss of traction in the markets as much as Germany, which is experiencing a period of economic worry in emerging markets. Thus German stocks are at risk, but should actually benefit dramatically from a weak euro and affordable energy prices.
Woe Betide Emerging Markets in the Ledger of Industrial Nations
And it could get worse. Emerging markets, threatened by debt expansion persistently pegged to the U.S. dollar and lowered financing from weak energy prices, need to make real bank in the Western world. They did this where high paper profits existed. Neither America nor Europe would have reason to be pleased if their bonds or shares were to be sold on a massive scale. Unfortunately, financial downturns also leave the unpleasant aftertaste of not being conducive to eager consumption or investment.
And the moral of the story: one doesn’t need massive dollar appreciation. Federal Reserve Chairman Janet Yellen has good and helpful reasons to intervene. With a massive interest rate turnaround, she can make a dollar bull market from withering territory in emerging markets, or she can advocate smooth diplomacy with interest rates for the benefit of the global economy. She’s got the whole economic world in her hands. And I’m certain that she’s got very soft hands.