WASHINGTON — U.S. policymakers are unlikely to take action to stem the dollar’s rapid rise amid rising risks of global financial turmoil, analysts say, largely because a strong greenback is helping to fight domestic inflation.
The US dollar has appreciated as the Federal Reserve hikes interest rates to fight the highest US inflation in decades and investors switch money into dollar-denominated assets. The WSJ Dollar Index, which measures the dollar against a basket of other currencies, is up about 16% so far this year.
The strengthening of the dollar against other currencies is putting pressure on many other countries around the world, driving up the cost of dollar-priced imports and servicing dollar-denominated debt. This is particularly difficult for many developing countries, which are struggling with large debts and import much of their fuel, food and other goods.
Wealthier economies also face problems as their import costs rise. Japan, the world’s third largest economy, recently intervened in the currency markets to support the yen.
Treasury Secretary Janet Yellen says the US supports market-determined exchange rates, adding that the dollar’s strength is largely the product of Fed policy and subsequent capital inflows into the US. The Fed manages monetary policy, while the Treasury monitors US exchange rate guidelines.
Treasury Secretary Janet Yellen says US supports market-determined exchange rates.
Photo: Kevin Dietsch/Getty Images
Economists and former Treasury Department officials point to two reasons why the Treasury Department is unlikely to take any action to lower the dollar’s value — or slow its rise — anytime soon.
First, with the Fed on track to continue raising interest rates, any US FX intervention is likely to have a limited impact on the value of the dollar. Second, a strong dollar helps bring down inflation, and the Treasury is unlikely to want to take steps that could undermine the Fed’s efforts to contain inflation.
“The Treasury Department may fear that dollar strength will set the stage for foreign grievances and protectionist pressures in the US in the future, but their best short-term strategy is to try and keep their mouths shut,” said Mark Sobel, a former senior career Treasury Department official who is now the US Chair of the Official Monetary and Financial Institutions Forum.
The US has rarely moved to intervene in foreign exchange markets, notably under the 1985 Plaza Accords, in which the US, Britain, Japan, West Germany and France agreed to joint currency intervention to devalue the dollar. Over the next decade, the dollar fell and the yen rose.
But that intervention came just as the Fed had begun easing its rate hikes, giving Treasury and Treasury ministers room for effective intervention.
Federal Reserve Chair Jerome Powell said he expects interest rates to continue to rise as the central bank battles high inflation. Photo: Kevin Lamarque/Portal
“If they tried to do a plaza when [former Federal Reserve Chairman Paul] Volcker was energetic about it, I don’t think it would have been that successful,” said Nathan Sheets, the Treasury Department’s undersecretary for international affairs during the Obama administration. Given the market momentum created by the Fed, Mr Sheets said the Biden administration had no real choice but to embrace the dollar’s strength.
Fed Deputy Chairwoman Lael Brainard said in a speech on Friday that the central bank is monitoring global financial developments while it remains committed to bringing down inflation by raising interest rates high enough to slow US economic growth .
“Monetary policy needs to be tight for some time to be confident that inflation will get back on target,” she said. “We are committed to avoiding a premature withdrawal.”
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A strong dollar generally helps reduce US inflation by lowering the prices of goods and services imported into the US. It also usually dampens US exports, making them more expensive in world markets and slowing economic growth, which can also ease price pressures.
Those effects hurt U.S. exporters’ bottom line, but the Biden administration has made no effort to reverse the dollar’s rise because it wants to see lower inflation, the former officials say. Meanwhile, the US jobs market remains strong, mitigating the potential policy setback from dollar strength.
However, the risks posed to the global economy by the stronger dollar could be amplified. Central bankers around the world may feel they need to raise interest rates faster than expected to fight inflation in their own countries and prevent their currencies from depreciating further.
Their combined efforts could exacerbate the global economic slowdown. Investors may increasingly choose to seek refuge in US dollars, further increasing the value of the greenback and risking further market instability.
Even if those risks increase, Eswar Prasad, an economist at Cornell University, said the US will not take any action to slow rate hikes or otherwise change the course of the dollar until doing so poses a direct risk to the US economy . So far, the risks for the US are limited – while the benefits are tangible.
“I don’t see the Treasury Department or the Fed doing anything significant to ease the financial panic in other parts of the world,” Mr Prasad said.
Fed Vice Chair Lael Brainard said the central bank is monitoring global financial developments as it remains committed to curbing inflation.
Photo: Manuel Balce Ceneta/Associated Press
Write to Andrew Duehren at [email protected]
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