The New York Times: “Strong Dollar is Good for the US but Bad for the World”

For the rest of the world, it’s a no-win situation, said Eswar Prasad, an economics professor at Cornell and author of several books on currencies. At the same time, he said, the Fed has no choice but to act aggressively to control inflation: Any delay in action could make things potentially even worse.

Policy decisions made in Washington frequently reverberate widely. The United States is a superpower with the world’s largest economy and hefty reserves of oil and natural gas. When it comes to global finance and trade, though, its influence is outsize.

That is because the dollar is the world’s reserve currency — the one that multinational corporations and financial institutions, no matter where they are, most often use to price goods and settle accounts. Energy and food tend to be priced in dollars when bought and sold on the world market. So is a lot of the debt owed by developing nations. Roughly 40 percent of the world’s transactions are done in dollars, whether the United States is involved or not, according to a study done by the International Monetary Fund.

Patricia Cohen

The decision of the European Central Bank to continue to raise interest rates has been criticized, at least among the people I follow on Twitter, and on some level I understand those arguments. Recent inflationary pressures in Europe originate predominantly from higher energy prices and supply chain disruptions, factors that can hardly be influenced by the monetary policies of individual countries. Solutions for these issues require medium term restructuring and investments, not in the scope of central banks – and rising interest rates can even cause adverse effects by dampening financing opportunities for investments.

Five Facts about Inflation by Claudia Sahm

On the other hand, a stronger dollar exerts additional inflationary pressures on the rest of the world. As the world’s reserve currency, the dollar already enjoys an advantage in times of crisis, when investors seek out what they perceive as safer investments; coupled with higher interest rates, the rising demand for dollars pushes its value up and other currencies down. Therefore other countries have little choice than to follow suit to keep their currencies competitive for investors, to prevent an accelerated devaluation against the dollar and reduce imported inflation.

In the European Union, the issue is exacerbated by the fast-tracked transition from Russian oil and gas, with contracts and payments in euro as far as I know, so free of currency risks, to other suppliers – where I assume the contracts are signed in US dollars, so European customers end up paying higher prices as the dollar exchange rate against the euro rises. Traditionally, a weaker currency should provide an opportunity to increase exports by selling cheaper goods and services abroad – from the EU to the United States in this case. But because energy used in manufacturing is imported in large quantities, in Germany especially, manufacturing costs fluctuate up with the dollar, undermining the potential for an export-driven recovery.

Since the conflict in Ukraine shows no signs of immediate resolution, and with the Fed committed to continued interest hikes, I expect the crisis to continue. It will be interesting to follow if other measures, coming from governments directly, will manage to stem inflation – such as Germany’s recent decision to cap gas prices for consumers and businesses. In theory, this form of government intervention could help cool down inflation substantially by reducing both consumer and manufacturing costs, at the expense of a budget deficit – but Germany certainly has the surpluses to afford it.

In 1998, Alan Greenspan, a five-term Fed chair, argued that it is just not credible that the United States can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress.

The United States is now facing a slowing economy, but the essential dilemma is the same.

Central banks have purely domestic mandates, said Mr. Obstfeld, the U.C. Berkeley economist, but financial and trade globalization have made economies more interdependent than they have ever been and so closer cooperation is needed. I don’t think central banks can have the luxury of not thinking about what’s happening abroad.