Evidence of global recession continues to spread. With an “official” economic growth rate of 2.5 percent, the United States is perceived as an investment haven. International investors are converting foreign currency into dollars, much of it for investment here.
Those who have borrowed cheap dollars to convert to their country's currency are buying dollars to repay their dollar debts. This strong demand for dollars coincides with the Federal Reserve slowly ending its injection of billions of stimulus dollars.
The increasing strength of the dollar lends credence to its role as the international reserve currency. But it threatens to import recession from abroad, preventing the Fed from raising interest rates when deemed appropriate for the domestic economy. What does this mean for American citizens?
According to the International Monetary Fund's 2013 figures, the Eurozone is in recession of 0.4 percent, with Spain and Italy experiencing negative growth. Since 2013, France and Germany, the European Union's economic engine, have experienced negative growth.
Despite huge stimulus, Japan appears as an economic basket case. IMF data show China's growth rate has fallen to 7.7 percent.
Falling growth rates, relative to that of the United States, encourage bearish depositors to hedge their local currency holdings by buying dollars. These are known as “Eurodollars” if held by non-U.S. residents.
This flood of foreign currencies into dollars is reflected in exchange rates. According to the Fed, on Oct. 10, the Japanese yen stood at 107.83 to the dollar or down 9.9 percent on the year. Despite being pegged to the dollar, the Chinese yuan, at 6.13, was down 1.6 percent. At $1.26, the euro was down 6.6 percent.
By flooding the world with trillions of cheap, low-interest dollars, the Fed encouraged investors to engage in the “dollar carry trade.” For example, a French company, facing local euro borrowing costs of 8 percent, might borrow dollars at 4 percent. By selling the dollars for euros, driving the price down, it would invest at an interest cost, saving 4 percent. However, with a rising dollar threatening the borrower with higher repayment costs, the company might unwind its dollar carry trade by selling euros to buy dollars to pay off its loan. In doing so, it increases demand for dollars, helping to boost the dollar's price.
This week, the Fed may end its stimulus purchase of $10 billion a month in Treasury notes, making dollars less available just when demand is increasing. This will exert further upward price pressure.
However, a rising dollar will allow the importation of international deflation into a sputtering U.S. economy. A German automobile, discounted in euro terms to compete in its deflating domestic market, will be discounted further in dollars that buy more euros. Therefore, its dollar price is discounted twice against its GM competitor, forcing GM to discount its domestic price.
Should consumers delay their purchases in order to buy cheaper, recession threatens. The Fed's freedom to raise interest rates will be curtailed.
Assuming a strong dollar retains its international reserve status, Americans holding dollars might well proclaim, “Long live the King!”
John Browne, a former member of Britain's Parliament, is a financial and economics columnist for Trib Total Media. Contact him at johnbrowne70@yahoo.com.
