A man exchanges US dollar bills at an exchange office.
Muhammed Semih Ugurlu | Anadolu Agency | Getty Images
With the dollar hitting 20-year highs against a wide range of key foreign currencies, the specter of a historic forex crisis is looming.
While now largely forgotten by all but those of us who reported on the event, the 1985 US dollar surge, which has now entered the machine on the way back, forced the then G-5 industrial nations to intervene in the currency market and weaken the dollar substantially .
At the September meeting in Manhattan, the G-5 announced the “Plaza Accord” (created at the iconic Plaza Hotel in New York) and took coordinated action to weaken the dollar, selling dollars in the open market while the US cut interest rates to reverse the dollar’s rate. meteoric rise.
The goal was multifaceted—to relieve the strain on the then-strict foreign exchange trading system in which many of the world’s currencies were pegged to the dollar, to make American goods cheaper in overseas markets amid growing U.S. trade deficits, and to further coordinate global interest. rates in order to synchronize world economic cycles.
Similarly, in late 1994, 1997, and 1998, the rising dollar caused great turmoil not only in foreign exchange markets but also in the global economy.
In short, although it was a much more complicated event on the Mexican side of the border, as the Fed tightened policy in 1994 to cool the US economy, the Mexican peso collapsed against its lower peg against the dollar, forcing Mexico to abandon the link. , which sent the peso into freefall that year.
Once the link was severed, Mexico faced massive inflationary risks as the peso collapsed against the dollar. The United States actually loaned Mexico $50 billion in cash to right its economic ship as inflation rose to 52% south of the border.
It was one of the factors that forced the Federal Reserve to halt rate hikes in what was then the worst year for US bond markets in a decade.
Again, the 1997 Asian currency crisis and the 1998 Russian debt default (and the related collapse of hedge fund Long-Term Capital Management) forced the Fed to either delay rate hikes or cut them in 1998 due to the systemic financial risks posed by the latter event.
In both cases, global currencies were in turmoil, markets crashed, and the Fed was forced to either preempt planned rate hikes or cut them suddenly to reduce the growing risk of overseas economic contagion that could topple the U.S. economy from the collapse of emerging markets. .
We may be approaching another similar pain point today which Aggressive Fed interest rate increases cause further tension in foreign exchange markets, which could subsequently lead to increased global market and economic risks.
Today, the British pound is at its lowest level against the dollar since 1985. The euro is trading for less than $1 on foreign exchange markets, while the weakening of the Japanese yen, at a 24-year low against the dollar, prompted the Bank of Japan to intervene for the first time since 1998 to support its currency.
Emerging market currencies are under similar pressure, threatening a currency crisis that could once again disrupt global financial markets, already in a global downtrend, and force the Fed to change policy.
Such is struggling with inflation at homeby raising interest rates and tightening credit conditions at the fastest pace in decades, the Fed is exporting inflation to other countries and making American goods more expensive in overseas export markets.
A stronger dollar further reduces the repatriated profits of US multinational corporations, putting corporate profits at even greater risk in an already weakening US and global economy.
In any political endeavor there are risks and rewards associated with both acceptable and unacceptable trade-offs.
We are now reaching an unacceptable point.
Witness the accelerating rise in global interest rates, the extremely rapid appreciation of the dollar and the parallel plunge in global stocks.
I have long argued that the Fed will raise rates until something breaks. Today you can hear the sound of markets tearing up.