In 1975, C. Fred Bergsten, an expert on international finance, wrote The Dilemmas of the Dollar. Bergsten discussed the post-1945 monetary system and floating exchange rates, but he focused on the weak dollar, which was contributing to inflation and a poor economy. Economic policy failure by Presidents Lyndon Johnson, Richard Nixon, and Gerald Ford, as well as the Federal Reserve, had caused a collapse in the dollar.
By the early 1980s, after Fed Chairman Paul Volcker had raised interest rates sharply in order to crush inflation, the dollar was again strong against a basket of currencies. Because of interest rate differentials, U.S. rates were higher than the rates of its principal trading partners, and because of restored confidence in the U.S. economic and political outlook, the dollar surged. There are clear parallels between the early 1980s and today.
The Fed’s trade-weighted dollar index has risen at an annualized clip of 14% so far this year. Inflation is at the hottest level since the 1980s, when Volcker raised rates as high as 20%. Current Fed Chairman Jerome Powell has said economic pain is necessary to curb inflation.
The euro is trading below parity at 0.99 euros to one U.S. dollar. The British pound is trading at a 37-year low against the dollar. Almost unbelievably, the market is musing about the British pound trading at parity with the dollar.
Because of dollar appreciation, earnings after adjusting for relative currency values are lower for U.S. multinationals, which dominate the capitalization of U.S. equity markets. The strong dollar weighs on market valuation and sentiment. Bear markets tied to a recession typically feature a 25% drop from prior peaks. The too-strong dollar is also sowing the seeds of a new emerging market debt crisis. Developing countries are facing inflation, rising interest rates, and unsustainable levels of debt. The rapid rise of global interest rates, food and fuel prices, and those of other key commodities is taking a toll on the world’s poorest countries. The International Monetary Fund estimated that 30% of emerging market countries and 60% of low-income countries are already in or are nearing debt distress.
So why are we sailing into a perfect storm of an overvalued dollar, falling equity markets that weigh on confidence and consumption, and the prospect of an emerging market debt crisis? The predominant answer: poor policy by the Biden administration and Democratic Party elites.
Yes, excessively loose monetary policy contributed to today’s inflation and high and rising interest rates. Still, monetary policy was equally expansionary after the Great Recession, from 2008 to 2015. Short-term rates were fixed at zero for seven years. Yet, as Robert J. Barro noted, inflation was low and contained at or below the Fed’s 2% target.
Why were the inflation results so different from 2021 onward?
Professor Larry Summers explained in February 2021 that the stimulus from the American Rescue Plan was five times larger than economic conditions warranted. Wage and salary incomes were running about $30 billion a month below pre-COVID-19 forecasts and the gap was declining. That said, increased benefit payments and tax credits from the American Rescue Plan would total about $150 billion — a ratio of 5 to 1.
President Joe Biden is the captain of the economic ship of state. He and Democratic elites charted the course, which brought us to an economic hurricane of an overvalued dollar, a looming emerging market debt crisis, and an ever-increasing risk of a severe recession.
James Rogan is a former foreign service officer who later worked in finance and law for 30 years. He writes a daily note on finance and the economy, politics, sociology, and criminal justice.
