Strong US Dollar Chatter is Back

No matter what the US dollar is doing lately, commentators we follow probably won’t like it. When it is weak, we often find they warn it makes America import inflation (broadly rising prices across the economy). And when it is strong, we still see many bemoaning it. The latter is the case now, with chatter focussing on the strong dollar’s alleged dangers for Emerging Markets (EM), whose currencies are at multi-year lows versus the greenback.^[i] Officials in South Korea, India, Indonesia and Malaysia are all talking about a too-strong dollar and intervening in currency markets, with some starting to act.^[ii] We see this attitude regularly when EM currencies get weak, in large part because we think sentiment remains scarred from the late 1990s’ Asian Currency Crisis. But in our view, it isn’t the big economic risk headlines we follow make it out to be.

For one, we don’t think now looks like the late 1990s. Then, Emerging Asia had high levels of dollar-denominated debt, which they financed cheaply by pegging their currencies to the dollar in a fixed, or static, exchange rate.^[iii] But we find such arrangements are difficult to maintain when markets move against them. When several currencies came under pressure from the then-strengthening dollar, monetary policy institutions burned through reserves, selling dollars to buy their local currencies and support them to defend the pegs. Eventually, reserves ran dry and they had no choice but to drop them.^[iv] The currencies then plummeted, with the sudden devaluations leading to financial crises and International Monetary Fund (IMF) bailouts in South Korea, Indonesia and Thailand.^[v] Malaysia and developed-market Hong Kong came under severe pressure. But in all cases, we think it was the fallout from defending and discarding currency pegs that caused havoc—not just the dollar’s swings.^[vi]

That isn’t an issue today. All but Hong Kong have floating currencies, and their foreign exchange reserve war chests are far larger.^[vii] Intervention talk we have seen centres more on curbing volatility than on defending certain values. Not that intervention is riskless, but we don’t think these nations look poised to deplete their reserves in short order.

As for the talk we have seen of weak EM currencies disrupting trade flows and damaging global economic growth in the process, we doubt it. The dollar was stronger versus a broad currency basket in late 2022 than it is now, and we don’t recall some massive trade crisis then.^[viii] Rather, we find weak currencies create winners and losers, which is why a lot of businesses hedge for them. On the plus side, they make export revenues worth more when converted from dollars (or whatever) back to the home currency. That enables exporters to cut prices overseas to gain market share or reap larger profits from currency conversion. The downside is a weak currency makes imported labour, components and raw materials (including energy) more expensive, but we find it all tends to even out over a cycle. And, again, businesses tend to hedge for currency swings, mitigating a lot of impact at the company-specific level.

Those concepts might be abstract and theoretical, but real-world facts aren’t. Emerging Asian currencies have been weak for a couple of years now.^[ix] Yet their economies are growing nicely. Indian gross domestic product (GDP, a government-produced measure of economic output) is amongst the world’s fastest even when you strip out some of the idiosyncratic items that skew it.^[x] After a brief contraction at 2022’s end as household spending hit a speedbump, South Korean GDP rebounded in early 2023 and grew 2.5% annualised three straight quarters through Q4 2023.^[xi] Indonesian GDP grew 5.0% last year.^[xii] Malaysia grew 3.7%, which is slow only in comparison to 2022’s 8.7% jump.^[xiii] In our view, currency markets aren’t screaming that these nations are in trouble. Rather, we think weakness is the logical result of these nations’ maintaining swift money supply growth whilst US money supply was contracting.^[xiv] Yes, the price of money, too, is all about supply and demand.

Lastly, there is no guarantee Emerging Asian currency weakness persists indefinitely. US Federal Reserve rate cuts, whenever they happen, could alter the all else equal, money flows to the highest-yielding asset calculus. In our view, the geopolitical and market jitters that seem to have sparked a flight-to-safety mentality will likely ease in time, as they typically do.

So we suspect this will go the way similar EM currency talk went in 2013, 2015 and 2018: lots of warnings and little fallout. In our view, those bouts proved to be bricks in the long 2009 – 2020 global bull market’s proverbial wall of worry.^[xv] We think this latest round should do the same, especially with so much attention heaped on it.