Why the dollar is so strong despite inflation? Inflation is measured by the cost of a basket of goods and services over time. You may be surprised to learn that while prices are increasing at the fastest pace since the 1980s, the US dollar has simultaneously been rising in value and is the strongest that it has been since 2002. The dollar has increased by 11.5%, even as inflation has risen from 7% to over 9%. How can these seemingly contradictory things both be true?
A strong dollar can make products imported into America cheaper and make trips abroad less expensive for American travellers. Big companies that operate in multiple countries, such as Johnson & Johnson, have recently complained that the rising dollar could hurt their profits since foreign sales lose value when converted back into dollars. They become less competitive with local companies as their products become more expensive overseas.
Why the dollar is extremely strong right now?
The dollar has been rising in large part because the Federal Reserve is on track to increase interest rates faster than other major countries. The American central bank started to lift interest rates in March after keeping them at near zero for much of the pandemic and carried out another big rate increase. Higher interest rates make the dollar more attractive to investors since it means they would get a bigger return.
More recently, it has less to do with the US and more to do with a global downturn. Russia’s invasion of Ukraine has also strained European economies and made natural gas prices high, making the US economy look healthier in comparison. As the growth outlook for the world economy worsens, investors have grown more concerned and putting their money into safer assets like US Treasury bonds. In other words, the dollar is acting as a haven. That increased the US currency’s value.
What does this mean for the world?
For other countries around the world, a strong dollar pushes import prices up, which can create inflation in those regions. The impact can also be brutal for emerging economies. When US interest rates are low, global investors tend to invest more in emerging markets, or the economies of nations that are transitioning into developed economies. But when rates start to rise in the United States and the dollar climbs, money starts to flow out of those countries.
Some developing nations are better equipped to handle this since they have more reserves or their exports are priced in dollars and have been rising in value, but other countries could struggle. For example, Sri Lanka’s economy is starting to crumble as it deals with a mountain of debt and not enough US dollars to pay for imports of essential goods. Countries that borrow heavily in dollars could suffer because it becomes harder to make repayments as the dollar rises and their currencies depreciate.