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Dollar surge leads to big terms of trade shock


The US dollar has surged almost 14% from its low last year in trade-weighted terms. This has led to a huge terms of trade shock (the price of exports compared with the price of imports) affecting any country that imports a lot of energy, which trades in dollars. On top of that, in Europe and the UK, at least, are the very unwelcome inflationary impacts of a rapidly declining currency on inflation rates already at multi-decade highs.
Old market hands have started to mutter about the possibility of central bank intervention to stem the dollar’s broad strength. A few are even starting to wonder whether such intervention might be coordinated, in an echo of the Plaza Accord in 1985, when the then Group of Five major central banks (the US, Germany, France, UK and Japan) agreed to push up the value of their currencies against the dollar. They were so successful that there was a subsequent meeting in France in 1987, dubbed the Louvre Accord, to stabilise the dollar, which had lost a quarter of its value by that point. As much as the grumbling about the dollar’s strength is likely to get louder and there may be various ad hoc interventions by developed-world central banks (as Japan did), it’s doubtful we will see anything coordinated for a good while for three main reasons.
First, many countries in the developed world didn’t have to be so late raising interest rates and doing so in such an anaemic manner when they did. The likes of the Bank of England or the European Central Bank should have been a lot quicker and more aggressive in tightening monetary policy. Japan hasn’t done anything for what seems forever. They can hardly complain if market participants find other, better places to plonk their cash.
The trouble now is that even if any of them try to catch currency markets off guard by reversing course and seemingly become more aggressive, their previous sloth makes it unlikely that markets will believe for long in any damascene conversion. All three have made it plain that economic growth worries trump inflation worries. The ECB also thinks its job is to hold the euro together. And with Asia slowing in general and China on its knees. So, any rise in their currencies as a result of a bit more monetary aggression is likely to be short-lived, even if backed up by a few salvos of intervention.
Which brings us to my second point. Economically, a strong dollar suits the US in a way that it didn’t in 1985. The greenback’s vertiginous rise in the late 1970s and early 1980s was driven by a Federal Reserve waging a war against inflation by dint of a monetary policy of sustained savagery.
Besides the damaging double-dip recession of the early 1980s, often forgotten is that this policy also led to the Latin American debt crisis. That crisis was sparked by the effect of sharply higher interest rates and weaker currencies on a huge pile of foreign-currency loans, mostly from large American banks, which promptly became insolvent.
By the mid-1980s, though, inflation rates had fallen dramatically. The US was keen on looser monetary policy and a weaker dollar to help both its exporters and the emerging world.


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