Bought something from the United States recently? You might have been surprised by the price tag. The US dollar has appreciated by more than 15 per cent against the currencies of major US trading partners since the start of the pandemic. It's even worse if you live in a developing country. For Brazil, the dollar is up 37 per cent. For Sri Lanka, it's up 43 per cent. For Turkey, it's up a whopping 208 per cent.
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The high US dollar is causing challenges for developed and developing countries alike. For developed countries like Australia, it makes fighting inflation just that little bit more difficult. But for developing countries like Brazil, India, Indonesia, South Africa and Turkey, it risks triggering a financial crisis. Luckily, there are things we can do at home, and abroad, to help countries cope. If Australia's new government is serious about improving our reputation in the Asia Pacific, it best start now.
Why is the US dollar so high? The culprit is inflation. Inflation in the United States is running at an eye-watering 8.5 per cent over the last 12 months, the highest since 1981. It's no surprise inflation is high. Demand for goods has skyrocketed. Americans have unleashed hundreds of billions of dollars that they saved during the pandemic. The money they would have normally spent on services during the pandemic has been spent on goods - given reluctance or inability to go to restaurants, bars and clubs - adding more pressure on the price of goods.
On top of that, the US government has undertaken fiscal stimulus worth a huge 25 per cent of GDP over the course of the pandemic, some of which will continue for several years, while the Federal Reserve has only just begun dialling back its massive stimulus program. Many economists have warned that the Fed has been too slow, and the Biden administration too generous.
And that's just the demand side. While the demand for goods is skyrocketing, the supply of goods is shrinking. Supply chain challenges, sick workers, geopolitical conflicts and tensions, and the so-called Great Resignation have made supplying goods and services much harder than usual. It's a double-whammy: increased demand and contracted supply has sent prices through the roof.
In developed countries, like Australia, high inflation in America makes fighting inflation at home more difficult. The Reserve Bank of Australia has increased interest rates to try to tame inflation. But when the United States increases interest rates at the same time, investors shift their money into the United States and out of the rest of the world to get the higher return. This weakens the Australian dollar, making our exports cheaper. This might sound like a good thing, but cheaper exports means higher global demand for our goods and services, pushing up prices and making inflation harder to reduce.
Australia's challenges from a higher dollar are nothing compared to the challenges faced by developing countries. Investment in developing countries shrinks as capital leaves their economies to get higher returns in America, hurting growth in countries where it is desperately needed to reduce poverty.
For developing countries with debt denominated in foreign currencies (which is many of them, to varying degrees), things are worse still. As their currencies fall in value, the size of those foreign-denominated debts increases. If their currencies fall by enough against the US dollar, a currency crisis can ensue, as has already happened in countries like Sri Lanka.
Emerging markets have been put in an impossible position. If they want to stabilise their currency, they need to raise interest rates. But if they raise interest rates, they choke off the economic growth they need to reduce poverty. It's a brutal trade-off.
What to do? Developed countries like Australia have the tools and capacity to manage their own risks. The Reserve Bank can tame inflation by raising interest rates, which it is. APRA can use macroprudential measures like loan-to-valuation ratios to ease pressure on housing prices. The government can dial back government spending, raise taxes or change the composition of spending to ease inflationary pressures while supporting the most vulnerable.
The government can also use supply-side reforms to target price pressures in particular areas. Easing regulatory burdens on the importation of cars would help reduce car prices. Abolishing remaining tariffs would directly reduce prices across a range of consumption goods. Easing cabotage restrictions would reduce freight and transport costs, while easing occupational licensing restrictions would make a range of services cheaper to buy.
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Developing countries don't have the same tools available. Their monetary policies are less effective because of shallower financial systems. Less developed markets and institutions make macroprudential measures and targeted fiscal measures difficult. It's hard to dial back government spending in any country, let alone ones that suffer high levels of poverty.
Developing countries need help from the rest of the world. The first thing we can do is get our own houses in order and tame the inflation in the rich world that's causing havoc in the developing world. Central banks have been slow to act on this front but are now raising interest rates to cool off inflation, and there is early evidence that supply-chain challenges are easing.
The second step is to help countries battle this trade-off between financial stability and economic growth. This means giving them the tools they need to support their currencies. If developing countries have the resources to buy their own currencies, they can push their exchange rates back up, reducing the size of their foreign-denominated debts and signalling to markets that their debts are sustainable.
Providing developing countries with bilateral currency swap lines is the best bet. These lines allow developing countries to access foreign currencies directly from foreign central banks and use them to buy their own currencies on international markets to push their exchange rate back up. Later on, once pressures have eased, they buy back the foreign currency and swap it back with the foreign central bank.
Bilateral loans - such as that between Australia and Indonesia - have the same effect. Ensuring international financial organisations - like the International Monetary Fund and Asian Development Bank - can provide financial supports quickly will provide another layer of support. Ensuring that support can be provided without developing countries needing to seek a formal loan program is vital to preventing the markets from panicking further about countries seeking assistance.
If there's one lesson we should take from COVID-19, it is this: the world is more interconnected than ever. Rising poverty or increased financial instability in one country is a problem for all countries. We all need to do our part, especially when we are part of the problem.
- Adam Triggs is a director within Accenture Strategy, a non-resident fellow at the Brookings Institution, a visiting fellow at the Crawford School at the Australian National University and a fellow at the e61 Institute. He writes fortnightly for ACM.
Adam Triggs
Adam Triggs is a partner at the economics advisory firm, Mandala, a visiting fellow at the ANU Crawford School and a non-resident fellow at the Brookings Institution.
Adam Triggs is a partner at the economics advisory firm, Mandala, a visiting fellow at the ANU Crawford School and a non-resident fellow at the Brookings Institution.
