Dollar, euro, pound and yen
The US dollar strengthened to its highest level in 20 years against a group of foreign currencies, which made repayments of loans due in US dollars more expensive and increased the potential for a global currency crisis.
Some small, heavily indebted countries in the world have already by default on their international debts, notably Zambia, Lebanon and Sri Lanka.
The strengthening US dollar threatens to worsen inflation by more than 70% in Argentina, NPR reported.
U.S. interest rate hikes like those imposed by the Federal Reserve often spell disaster for low-income countries, said Francesc Balcells, who manages emerging market debt at Dubai-based Frontier Investment Management Partners.
The poorest countries are the hardest hit by a strong US dollar
Poorer countries have larger debts in US dollars and they now have to pay more for imports bought in dollars as the currency strengthens. This comes as global food and fuel prices rise due to currency fluctuations and supply shortages caused by Russia’s invasion of Ukraine.
The most recent collapses in emerging markets, including the Asian financial crisis of the late 1990s, have always coincided with periods of rising interest rates in the United States, Balcells said.
The number of emerging market borrowers with distressed debt has doubled in the past six months, Bloomberg reported.
Many of the larger middle-income countries can weather this storm, Balcells said. But it’s a “perfect storm for emerging markets.”
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People in Ghana and Nigeria, Africa’s largest economy, are also facing financial hardship.
Food price increases hit the poorest households harder than the richest. Food accounts for 40% of the consumer price index in sub-Saharan Africa and less than 20% of the CPI in advanced economies, according to the International Monetary Fund estimates.
The US dollar has soared in 2022 amid global recession fears and aggressive interest rate hikes from the Federal Reserve.
Fueled by the Fed’s most aggressive interest rate hikes in more than a generation, the stronger dollar pushes down the value of other currencies, drives up the cost of imported goods, and fuels inflation in other economies.
This puts pressure on other central banks to raise interest rates at a time when an energy crisis and soaring consumer prices are already impacting their economies.
“Their ability to influence dollar strength is limited, meaning there is little prospect for near-term relief,” Fortune reported.
The United States was the first to enter a cycle of rising rates and this inflated the value of the dollar “because if you buy assets in dollars, you will get more yield on interest rates”, a said Martin Baccardax, London. bureau chief for The Street.
“People often tend to look to the US dollar when they feel a bit risk averse, they see it as a safe haven,” Baccardax said. “It stands to reason that people would buy US dollars in order to be more protective as they take risk off the table. It also inflates the value of the dollar…it increases prices and the purchasing power of US consumers , but there is a flip side to this.
Although it increases purchasing power, “it has this decreasing aspect when it comes to earning potential,” he added. “At the end of the day, while it’s good to have a strong dollar, it’s not good to have a seriously strong dollar because of the things it talks about in the global economy.”
The euro fell to its lowest level against the US dollar in 20 years, dropping below $0.99. The downward move came after the wealthy G-7 group of nations agreed to impose a price cap on Russian oil and Gazprom responded by announcing it would cut off gas supplies to Russia indefinitely. Europe via the Nord Stream 1 gas pipeline.
Investor bets on the falling value of the euro hit their highest level in more than two years in late August, mirroring the uptrend in the US dollar, according to the Commodity Futures Trading Commission. Speculators have piled up net short positions in the most significant bearish position against the euro since the start of the pandemic when the eurozone economy fell through a record post-war contraction.
The rise in bets against the euro reflects the role of the dollar as a “safe harbor in the event of a storm” as well as the fact that the United States is not as exposed to the gas crisis, said David Adams, head of G10 FX strategy at Morgan Stanley.
Betting against the Euro carries its own risks. The long-standing “flow of money” out of Europe to invest in the United States and other regions could reverse over the next six to 12 months as the European Central Bank hikes rates, making more attractive euro zone bonds, Adams said.
The British pound also fell against the dollar on Monday to $1.1475 – its lowest level since 1985 – ahead of the announcement that Liz Truss, Britain’s fourth prime minister in six years, would be next to take the job.
The pound has been hammered in recent months by soaring inflation – the highest of any G-7 country.
Truss inherits an economy facing the worst cost of living crisis in a generation, with inflation hitting 10.1% in July. Deutsche Bank warned on Monday that the risks of a “pound crisis” should not be underestimated.
Bank of England chief Andrew Bailey has dismissed the idea of an impending monetary crisis in the UK. “But the rare sight of the pound and UK government bond prices falling in tandem since ringing alarm bells that there is something stranger than a love for the dollar or the ebb and flow of volatile currency markets,” wrote Mike Dolan for Reuters.
Japan, the world’s third largest economy, has seen the yen fall to its weakest value against the US dollar since 1998. The Japanese currency – the second most traded against the dollar – is near the 146 mark that triggered joint action with the United States in 1998. support him, reported Fortune. The yen experienced a 40% climb of USD/JPY since the end of 2020.
“I see more pain ahead for those who have the yen long,” Mike Zaccardi, assistant instructor in finance at the University of North Florida, wrote for invest.com. “Erik Nelson of Wells Fargo agrees – he expects USD/JPY to hit 150 later this year.”
Examples of past currency crises that led to recessions
examples of monetary crises that led to recessions include the crisis of the Weimar Republic in Germany after the First World War, the Mexican peso crisis of 1994, the Asian crisis of 1997, the financial crisis of 1998 in Russia, the Argentine crisis in the late 1990s, the crisis economic crisis in Venezuela in 2016, and the Turkish crisis in 2016.
What could slow down the crisis?
One of the possibilities for alleviating a possible monetary crisis would be downturn in the US economy this slows the pace of tightening by the Federal Reserve and, by extension, weakens the dollar.