On September 28, 2022, the US dollar index broke through the 114 mark, with an increase of more than 20% during the year, hitting a new high since May 2002. Under the strong dollar, the currencies of major economies depreciated sharply, and the currencies of some developed economies fell even more than emerging market economies. As of the end of September, among the currencies of developed economies, the exchange rates of the Japanese yen, the British pound and the euro against the US dollar have fallen below 20-year or even 30-year lows, with depreciation rates of 27.3%, 22% and 16.3% respectively during the year. Among the currencies of emerging market economies, the exchange rate of the Russian ruble, the Brazilian real and the Mexican peso against the U.S. dollar increased, but overall, they appreciated against the U.S. dollar, with appreciation rates of 26.7%, 4.6% and 2.2% respectively during the year. The exchange rate of the RMB against the US dollar showed a trend of depreciation. The exchange rate fell by 14.1% during the year, but it was lower than the decline of some major developed economies against the US dollar.
Rising global risk aversion and sharp rate hike by the Fed boost the dollar
From the perspective of the fundamentals of the U.S. economy, the current state of the U.S. economy is not enough to support the continued appreciation of the dollar this round. Currently, the U.S. economic growth outlook is weak and inflation remains high. In the first quarter of 2022, the U.S. gross domestic product (GDP) fell by 1.6% year-on-year, and in the second quarter by 0.6%, with negative growth for two consecutive quarters, and the U.S. economy has fallen into a technical recession. At the same time, the United States is plagued by inflation, which has been above 8% from March 2022.
Therefore, the main reason for this round of dollar appreciation should be attributed to the rise of global risk aversion amid geopolitical conflicts. The Ukrainian crisis that broke out in February this year led to a surge in global risk aversion, and international capital continued to increase its holdings of U.S. assets, pushing up the U.S. dollar index. On the day of the outbreak of the Ukraine crisis (February 24), the safe-haven index VIX (if the VIX is higher than 20, it means that panic has entered the market) soared to 37.8. Although it fluctuated slightly, it mostly hovered around 30. According to the monthly International Capital Flows Report (TIC) released by the U.S. Treasury Department, from March to July 2022, the net inflow of overseas private capital to U.S. long-term and short-term securities and bank deposits reached $525.4 billion. This shows that the willingness of overseas private capital to increase its holdings of US assets continues to strengthen.
The sharp increase in interest rates by the Federal Reserve is also the dominant factor in this round of dollar appreciation. In order to control domestic inflation, the Federal Reserve will start a mode of sharp interest rate hikes in 2022. At the interest rate meeting on September 22, the Federal Reserve once again announced an interest rate hike of 75 basis points, accumulatively raising interest rates by 300 basis points during the year, which is the highest frequency of interest rate hikes since 1981. At present, the target range of the US federal funds rate has risen from 0-0.25% at the beginning of the year to 3%-3.25%. The rapid and rapid rate hike by the Federal Reserve has greatly increased domestic interest rates and short-term government bond yields. As of the end of September 2022, the U.S. three-month Treasury bond yield has risen to around 3.3% from around 0.1% at the beginning of the year. Rising Treasury yields have made holding dollars more attractive.
The currency trends of developed economies and emerging market economies are different under the strong dollar
What makes this round of dollar appreciation different from the past is that some developed economies have depreciated more against the dollar than emerging market economies. From the perspective of some advanced economies, exogenous shocks, more fragile economic fundamentals and slow interest rate hikes have made their exchange rates fall even more.
The Ukrainian crisis has triggered a rise in global energy prices, hitting some advanced economies harder. Compared with emerging market economies, European countries and Japan are more dependent on energy, and rising energy prices have caused these countries to soar import and production costs, leading them to deep energy crisis and economic recession. In 2021, 27% of the EU’s oil, 41% of natural gas, and 47% of coal will come from Russia, and Japan will rely on imports for nearly 88% of its energy. Driven by rising global energy prices, in March 2022, the EU’s energy price growth rate was as high as 44.3% year-on-year, and then it remained at around 40%; 0.5% climbed to 2.5%, ending 30 years of deflation and entering an era of inflation. With Russia’s energy supply sharply reduced this year, when the northern hemisphere’s winter energy demand peaks, the natural gas market supply in the European market will struggle to meet market demand. At that time, Europe may implement energy rationing, and the real economy will face a greater impact.
More fragile economic fundamentals in some advanced economies have also driven sharp currency depreciations. While the energy crisis has weakened corporate profits in developed economies, it has also pulled them into the abyss of balance of payments deficits. Since 2022, the trade receipts of the 19 EU countries have continued to show deficits, with a total deficit of 177.39 billion euros from January to July; in August 2022, Japan’s trade deficit reached 2.8 trillion yen (about 20.35 billion US dollars), a record 40 years. new high since. The widening of the balance of payments deficits in European countries and Japan also exacerbated the depreciation of their currencies.
Under the pressure of the Federal Reserve to raise interest rates sharply, the fragile economic fundamentals of some developed economies not only cannot support their currency values, but also greatly limit their interest rate hike process, which also makes their currencies continue to depreciate. Constrained by fragile economic fundamentals, the European Central Bank has been implementing monetary easing policies for the past 11 years. However, the start of the Fed’s interest rate hike process and the recent high inflation pose a dilemma for the ECB. On July 21, the European Central Bank announced an interest rate hike of 50 basis points, ending 11 years of loose monetary policy. On September 8, it raised interest rates by an unprecedented 75 basis points. Britain has already hiked rates seven times since December 2021, raising the policy rate to 2.25%. In order to maintain economic growth, Japan continued to maintain the quantitative easing policy. The hesitation of European countries to raise interest rates and the divergence of monetary policy in Japan and the Federal Reserve have exacerbated the devaluation of their currencies.
From the perspective of emerging market economies, their relatively sufficient foreign exchange reserves and foreign trade resilience form strong support for their currencies. On the one hand, emerging market economies have sufficient foreign exchange reserves, making it relatively easier for them to use foreign exchange reserves to intervene in their own exchange rates. For example, in order to curb the sharp fluctuations in the exchange rate, the Reserve Bank of India has continued to use foreign exchange reserves to intervene in the foreign exchange market. On the other hand, the trade resilience of emerging market economies has provided strong support for their currencies. Relying on its special status as a major energy country and rising energy prices, Russia’s trade surplus has continued to increase this year. From January to July, Russia’s current account surplus surged to $167 billion, compared with $50 billion in the same period last year. China’s trade surplus also remained relatively high. In July 2022, China’s trade surplus reached US$101.27 billion. Trade resilience has provided some support for the exchange rates of Russia and China.
Europe’s deep energy crisis led to a persistent deficit in trade receipts, and the euro fell below more than 20-year lows against the dollar. The picture shows a gas station in Bonn, Germany, taken on September 1, 2022.
Dollar appreciation will strengthen world recession expectations
The impact of the appreciation of the US dollar on the world economy is mainly manifested in the following aspects.
will exacerbate global poverty and shrink global trade. On the one hand, the appreciation of the U.S. dollar has made key U.S. dollar-denominated imported food and fuel more expensive, greatly increasing the pressure on residents to survive. For example, Nigeria, an African country that relies heavily on foreign food supplies, has a food inflation rate of as high as 23.12% in August 2022, which makes it difficult for the low-income population in the country to maintain a basic life, and the number of poor people across the country has surged. On the other hand, the continued appreciation of the dollar will exacerbate the contraction of global trade. The continuous appreciation of the dollar has made the prices of imported goods in many countries rise sharply, which will certainly reduce the import demand of importers. According to estimates, if the US dollar appreciates by 1% against all other currencies, the total world trade volume will drop by 0.6% to 0.8% in one year.
It will push up the risk of global debt default, and in severe cases will lead to a debt crisis. The continued appreciation of the dollar will increase the debt default risk of debtor countries by increasing the debt balance and financing costs. According to IMF statistics, by the end of 2021, the total external debt of emerging market economies will reach 11.9 trillion US dollars, a year-on-year increase of 5.8%, and external debt will account for 29.7% of GDP. According to data from the Institute of International Finance, from March to July 2022, emerging market economies experienced a net outflow of equity capital for five consecutive months, totaling more than $30 billion. On July 6, Sri Lanka declared national bankruptcy, becoming the first emerging market country to default on its sovereign debt in 2022. It is expected that the impact of the appreciation of the US dollar will spread to more countries.
The appreciation of the dollar combined with the Fed rate hike will likely push the U.S. and even the global economy into recession. For the United States, the appreciation of the U.S. dollar combined with the Fed’s interest rate hike has pushed up the yield of short-term government bonds, causing the yield of government bonds to invert (the yield of short-term government bonds is higher than the yield of long-term government bonds), which will not only increase the financing costs of financial institutions and enterprises, It will also strengthen recession expectations. Globally, the appreciation of the U.S. dollar combined with the Fed rate hike has pushed many countries to the brink of recession. The International Monetary Fund (IMF) predicts that more than a third of the world’s economies will fall into recession this year or next, with global economic growth falling to 2.7% next year from 3.2% this year. The World Bank also released a report pointing out that the global economy faces a growing threat of recession next year.
How to deal with the impact of dollar appreciation on China
Considering that the Federal Reserve will continue to implement a tough monetary policy, it is expected that the US dollar index may remain high this year, and there is still an upward possibility. At present, the effect of the Fed to curb inflation is still not obvious enough, so there is the possibility of further aggressive interest rate hikes. Although the US CPI in September fell to 8.2% year-on-year, if food and energy were excluded, the core consumer price index rose to 6.6% year-on-year.
Affected by the rise of the US dollar index, the exchange rate of the RMB against the US dollar has depreciated significantly since the beginning of this year, and the exchange rate of the RMB against the US dollar has broken through the 7.0 mark. For China, the main impacts of the appreciation of the US dollar include: the pressure of RMB depreciation caused by short-term capital outflows, the safety of China’s overseas assets caused by the risk of debt default in emerging countries, and the risk of a sharp decline in the balance of payments under the global economic recession. In this regard, China can respond from the following aspects.
First, we will focus on implementing the policy of “easing fiscal and stabilizing currency” to safeguard economic fundamentals and provide fundamental support for the RMB. At present, my country’s inflation level is not high. We should continue to implement loose fiscal policy to stimulate domestic demand, implement a prudent monetary policy to ensure production and exports, reduce the impact of the decline in external demand caused by the global economic recession, avoid a sharp decline in the balance of payments, and fully support the RMB exchange rate. Stablize.
The second is to pilot price-based cross-border capital flow management methods to avoid sharp depreciation of the RMB. Direct market intervention should be avoided as much as possible to avoid increasing unilateral depreciation expectations; price tools based on currency or foreign exchange markets can be used to make cross-border capital flow management measures closer to macro prudence.
The third is to seek cooperation in global debt governance and make every effort to ensure the safety of overseas assets. China should strengthen cooperation with other creditors under the multilateral framework, strive for the right to formulate debt rules, and expand China’s influence in the field of global debt governance.
Finally, we must actively promote RMB cross-border settlement, increase RMB foreign investment and product supply, steadily promote RMB internationalization, and encourage market players to use RMB in cross-border trade and investment, so as to reduce the risk of exchange rate fluctuations.
