A surging dollar makes it more difficult for borrowers in emerging market and developing economies to repay dollar loans.
The Federal Reserve’s aggressive efforts to wring out inflation have sent the U.S. dollar soaring to historic highs — further aiding the effort to get price pressures under control. Beware, however, the potential for unwanted side effects, a pair of economists warned in a new paper.
“The Federal Reserve has been among the most aggressive tighteners, and the dollar has appreciated sharply since mid-2021. Determined disinflation by the Fed and continued appreciation of the dollar could lead to more intense debt troubles for a range of EMDEs ,” wrote Maurice Obstfeld, economics professor at the University of California, Berkeley, and Haonan Zhou, a Ph.
Obstfeld, a former International Monetary Fund chief economist, and Zhou noted that more than 80% of emerging markets’ overall external debt liabilities are denominated in foreign currency, mostly U.S. dollars, and in some countries, “internal currency mismatch creates another potential fault line.” “Not only does a stronger dollar itself lead to tighter financial conditions by weakening debtor balance sheets … heightened risk aversion in world markets tends to appreciate the dollar as investors everywhere seek safety, implying another channel of negative correlation between dollar strength and EMDE macroeconomic performance,” they wrote.
Hear from Ray Dalio at the Best New Ideas in Money Festival on Sept. 21 and Sept. 22 in New York. The hedge-fund pioneer has strong views on where the economy is headed.
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