Reverse Currency War

There is every indication that the U.S. dollar should be tumbling compared to foreign currencies, with high inflation, a large trade deficit, loose monetary policy and consistently rock-bottom interest rates. Nevertheless, the value of the U.S. dollar’s is growing and has reached its highest value in the past 20 years.

One paradox leads to another: Instead of a currency war in which countries race to devalue their own currency and maintain competitiveness in the international market, a reverse currency war is now taking place — countries are raising the price of their money on the foreign exchange market to prevent inflation of import prices.

Despite the factors mentioned above, the value of the U.S. dollar is still appreciating, not only because the currency circulates within the U.S., but also because it is used around the world in business, investment, bank reserves and even criminal activities.

For precisely this reason, the demand for dollars around the world is offsetting the domestic factors that weaken its value. People still value a U.S. dollar as reserve currency in a world destabilized by war, an extraordinary price boom, climate change and factors which are weakening the value of currency in other countries.

Practically all types of trade transactions across the world are calculated in U.S. dollars. Increasing the value of the dollar puts pressure on inflation in the United States. But take a careful look: When the value of the U.S. dollar increases relative to a foreign currency, the degree of increase in value — for instance, 5% when with respect to exports, calculated in that country’s currency — can increase as much as 25% to 30% depending on the depreciation of that country’s currency compared to the U.S. dollar.

For precisely this reason, many economists believe countries are right to be concerned about the inflation on import prices. In 1971, Treasury Secretary John Connally told trade partners “the dollar is our currency, but it’s your problem” because countries were worried about a weak dollar at the time. The situation now is much the same — a strong U.S. dollar is a concern for many other countries.

A period of low inflation and extremely low interest rates in many countries followed the 2008-2009 financial crisis. Accordingly, devaluing currency became a competitive weapon aimed at stimulating economic development. Even so, the current situation is completely reversed; countries are following strong monetary policies to reconcile the factors causing domestic inflation.

A weak currency in this context increases inflation even more because it raises the price of imported goods and services. Goldman Sachs Group Inc. calculated that central banks around the world would have to increase interest rates by 0.1 percentage points to neutralize a 1% decrease in exchange rates. If all countries were to increase their interest rates in a similar manner, sooner or later the global economy would fall into a prolonged recession.

In the near future, people will be paying attention to the euro as it falls to a value equal to the U.S. dollar. Last week, yhou could exchange one euro for no more than U.S.$1.05 — very close to equilibrium — which forced the European Central Bank to announce it would now be closely following the inflationary pressures weakening the euro.

The British pound has also fallen to its lowest value in the past two years, even though the U.K.’s central bank has increased interest rates on four occasions. For a long time Japanese businesses have believed a weakened yen helps sell more goods to the rest of the world, thus Japan still follows a very loose monetary policy. But there are signs suggesting a change in course since Japan wants to prevent the yen from falling too far.

A strengthened U.S. dollar also worries developing countries because their foreign debt is chiefly calculated in that currency. According to the International Monetary Fund, up to 60% of less affluent nations are having problems with repaying foreign debt, and the number continues to grow as the value of the dollar trends upward. A strong U.S. dollar also reverses the trend of foreign investment in developing countries. Capital will return to places with higher profit potential, and avoid riskier places where their domestic currency holds a low value.