We have written recently about the ongoing strength in the dollar—the global reserve currency of choice—with the view that such large movements in the currency are akin to a shifting of the tectonic plates of global finance. As has happened in the past, such major shifts over short periods have a tendency to break things outside the U.S. For example, in the 1980s this led to the Latin American debt crisis, and in the late 1990s to the Asian Crisis/Russian Debt default. These fissures generally appear in the emerging markets, as these economies tend to be the most politically unstable, have limited foreign-exchange reserves, have often committed the “original sin” of taking on large amounts of dollar-denominated debt, and are more sensitive to tightening in U.S. financial conditions.
Adding to the woes in today's market is the commodity price shock resulting from the war in Ukraine. While this is acting as a cushion for the commodity exporters, it is doubling the painful impact for the commodity importers. Growing difficulties have already emerged in Sri Lanka, Pakistan, Nigeria, and increasingly in Egypt and other North African countries. What also seems a little different this time around are the large swings in many developed market currencies, including the yen, the euro, and this week, the pound sterling—its recent plunge has made it difficult to distinguish its behavior from that of an emerging market.
In this Economics Weekly, we discuss the bigger picture of the shift in policy drivers, and how those changes are creating friction in the financial markets, making the job of fighting inflation that much more difficult.
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Richard de Chazal, CFA, is a London-based macroeconomist covering the U.S. economy and financial markets.