Investing.com — A strong dollar has often been described as a “wrecking ball” for the global economy, driving up the cost of worldwide trade, tightening financial conditions, and inflation for countries, particularly those in emerging markets, but while king dollar is expected to continue its surging run, Capital Economics believes worries about the impact of the “wrecking ball” impact are overblown.
“The upshot is that while an appreciating dollar is a headwind for the world economy in the short run, it is usually not as harmful as often suggested,” economists at Capital Economics said in a recent note.
The U.S. has appreciated by 7% in trade-weighted terms compared to a year ago, reaching a fresh record high. In real terms, the dollar is the strongest since the Plaza Accord in 1985.
As most traded goods are priced in dominant currencies, chiefly the U.S. dollar, as the greenback strengthens, trade becomes more expensive globally.
While a “strong dollar poses a headwind to trade through this ‘invoice channel’, the share of trade that is negatively affected tends to be overstated,” the economists added.
Services trade, which accounts for a fifth of overall world trade, is much less affected by dollar strength. While falls in commodity prices, can mitigate increases in import prices, potentially dampening inflationary impacts.
Financial conditions tightening from dollar strength, meanwhile, pose a smaller threat to emerging markets than in the past, the economists said, with currency risks at their lowest levels in decades.
The renminbi is barely any weaker than it was a year ago due to the People’s Bank of China maintaining its 7.3 renminbi per dollar ceiling. But this exchange rate is at risk from US tariffs and the sharp fall in Chinese bond yields.
“If Trump goes ahead with plans to impose 60% tariffs on China, we think the PBOC would let the renminbi weaken as far as 8.0/$,” Capital Economic said.
“Such a move would no doubt embroil other Asian currencies, and EM assets more generally could get caught in the crossfire, at least for a short while,” it added.
A strong dollar is also bad news for the U.S. trade deficit, the economists said, as it reduces the competitiveness of U.S. exporters and increases the purchasing power of U.S. importers, leading to further political pressure for protectionist policies.
“By contributing to accumulated deficits, and through valuation effects, a strong dollar causes the US’ net external liabilities position to worsen, raising the risk of a disorderly adjustment further down the line,” Capital Economics said.
