What is wreaking so much havoc all over the world? You’ve probably heard that the U.S. dollar is rising often precipitously, which means any currencies caught on the other side of it—frankly, all of them—are being swept into crisis. This isn’t the first time, either, because during the last eight years or so this has happened repeatedly.
Set that aside, however, for a moment. While consumer prices accelerated, the dollar’s demise did not. On the contrary, apart from the latter half of 2020, the greenback has put back upon its seemingly inexplicable upward slope.
For one thing, the dollar’s increase correlates very nicely—meaning, not so nice—with several easily identifiable yet equally misunderstood issues. As a beginning, foreign governments end up selling their U.S. dollar reserve assets, primarily U.S. Treasuries, whenever the exchange value moves hard against their own.
In fact, this has been the primary complaint from several of those currently being hammered. Officials from New Zealand to the Reserve Bank of India (RBI) have desperately tried to explain their plight to the rest of the world—only no one has been listening—everyone else instead has been caught up in awe of Fed rate hikes and quantitative tightening (QT).
At first glance, those do appear as if they are the world’s chief issue, including India’s. What RBI’s top policymaker Shaktikanta Das said, on Aug. 5, was, “EMEs are facing a rapid tightening of external financial conditions, capital outflows, currency depreciations, and reserve losses simultaneously.”
The dollar goes up, signaling for the rest of the world “capital outflows, currency depreciations, and reserve losses”—each of those mere symptoms of that first dastardly first.
Take QT first—this is not (only) my judgement, by the way, it is, in fact, consistent with every bit of academic scholarship, any number of which have been produced by those doing the QT. A recent one from the Federal Reserve Bank of Atlanta, titled, “Working Paper 2022-08,” was published fortuitously right smack in the middle of our July to August to September dollar story which concluded:
“…I show that a passive roll-off of $2.2 trillion over three years is equivalent to an increase of 29 basis points in the current federal funds rate at normal times.”
Even making some conditional arguments (which are highly arguable), the study can only get it up to three-quarters of a percentage point under special circumstances. That’s it. Completely irrelevant.
So, no, QT cannot explain “rapid external tightening,” particularly given how little tightening anyone can associate with it, not to mention the fact that the current program was only recently begun and just last month ramped up.
So, then, rate hikes.
From New Zealand to, yes, the Bank of England, quite a list of overseas officials got the jump on the Fed, yet they’ve seen their currencies decimated anyway because we still need an explanation for “rapid external tightening” that cannot have been the usual suspect.
What does rapid eurodollar tightening end up looking like? Let’s go back to India one more time:
“EMEs are experiencing capital outflows and reserve losses which are exacerbating risks to their growth and financial stability.”
T-bill (and repo, therefore, SOFR) rates at the end of last month, and to start this month, have become once again grotesquely alarming (meaning, low). (SOFR is the secured overnight financing rate, which replaced the London interbank offered rate, or LIBOR, in the United States.)
Whether anyone can adequately explain it or not, the eurodollar is what happens, and will continue to happen, anyway.