The risk of a reverse currency war – 09/26/2022 at 07:43

André Cartapanis

Everywhere, priority is given to the fight against inflation and, at the moment, the American authorities do not seem to be too bothered by the appreciation of the dollar.  (Photo credits: Adobe Stock - )

Everywhere, priority is given to the fight against inflation and, at the moment, the American authorities do not seem to be too bothered by the appreciation of the dollar. (Photo credits: Adobe Stock – )

The rise in interest rates by central banks creates a new kind of currency war. The fight against inflation now takes precedence over the goals of competition. According to André Cartapanis, this new deal carries the seeds of a possible global recession.

By raising its key rates again on September 21, the Federal Reserve (Fed) confirmed a very clear tightening of the American monetary policy. By the end of 2022, the value of the currency in the United States should exceed 4.5%. And the dollar continues to appreciate against all currencies. On September 22, the euro hit a low not seen in 20 years, about 0.98 dollars (against 1.22 at the beginning of 2021).

This scenario complicates the European strategy to fight inflation by adding the exchange rate shock, through imported inflation, to the real shocks arising from the pandemic and the war in Ukraine, resulting in an increase in food prices and prices of oil. Faced with a rebound in inflation, the European Central Bank adopted a gradual and measured increase in its key rates, at a slower pace than in the United States, and this highlighted the attractiveness of the investment in the dollar and the rise of the greenback.

No industrial country has escaped such an event and developing countries have also been affected, exacerbating the weight of their external debt, which is mostly denominated in dollars. Hence the risk of a reverse currency war. By talking about currency wars, we usually refer to policies of competitive depreciation carried out by some countries, by playing a deliberately lax monetary policy or by intervening down the exchange market, in order to get the an undue advantage in international trade prices.

But some economists, Jeffrey Frankel for example, are now talking about a risk of a renewed currency war. Instead of participating in a race to the bottom of the foreign exchange market, it is a question of leading a race to the top, by promoting an increase in interest rates, or even by mediating the foreign exchange market. to be exchanged to stop depreciation, or even to cause appreciation. And this, not vis-à-vis the effects of foreign trade but to control inflation by neutralizing imported inflation and, however, by playing the card of imported disinflation. The consequence of this is to emphasize the restrictive nature of monetary policies and a general and accelerated increase in interest.

A parallel to the 80s

Can we get out of that scenario? A parallel can be drawn here with the state of the world economy during the 1980s. At that time, faced with double-digit inflation, the very rapid increase in American interest, accompanied by a bad deficit of budget, causing a very strong overvaluation. of the dollar, which was considered unsustainable for the American economy and led to the famous agreements in the Plaza in 1985, then in the Louvres in 1987, in the form of a coordinated strategy of industrial countries to lower the dollar. At the initiative of the United States, these agreements combined major interventions by central banks, including the Fed, and a more marked coordination of monetary and budget policies carried out by the United States, Germany and Japan. With proven success.

In 2022, the situation will not be the same. Everywhere, priority is given to the fight against inflation and, at the moment, the American authorities do not seem to be too bothered by the appreciation of the dollar. Unlike his Republican predecessor, who favored a weak dollar for business reasons, the strong dollar doesn’t seem to upset the Democratic president, or the Fed chair for that matter. However, there will be no coordinated interventions by central banks to counter distortions in the exchange rate against the dollar if the United States does not take the initiative. If global inflation does not fall, then the scenario of the reverse currency war seems inevitable, with an acceleration of the global increase in interest rates, model of US rates, and a very high risk of a global recession in the future.

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