The strong dollar Mismatch point

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The rise of the dollar will punish borrowers in emerging markets

From the print edition of The Economist, March 2, 2015

IN THE three months following the collapse of Lehman Brothers, as the world economy crumbled and investors scrambled for shelter, the dollar rose by 5% against a basket of other widely used currencies. In the past three months it has jumped by 11%; over the past year, by 22%—its fastest ascent in decades. The dollar is not yet in uncharted waters: one euro was worth one dollar in the early 2000s, for example. Its rise will help exporters in less vibrant parts of the world, notably Europe. But moves of this magnitude usually catch someone out, and the likeliest candidates this time are in emerging markets.

The principal reasons for the greenback’s rapid strengthening are simple to grasp. With Europe and Japan stuck in the doldrums, and China and other emerging markets slowing, America’s economy looks relatively strong. The IMF expects it to grow by 3.6% this year. The Federal Reserve has already begun to tighten monetary policy, by stopping its programme of asset purchases, and is now preparing the ground to go further. This week the Fed altered the wording it uses to describe its plans (see article), giving itself room to raise interest rates later this year—the first rise since 2006. With American monetary policy tightening, and other central banks still loosening, investors can make higher returns from dollar-denominated assets. In capital floods, and up the dollar goes.

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The mechanics of dollar strength may be simple, the effects anything but. American firms that sell abroad are hit: around a quarter of the profits of firms in the S&P 500 are earned in foreign currencies. The greenback’s ascent also mutes inflation, complicating the Fed’s judgment about when to raise rates.

But the chance of a shock is highest outside America. Companies around the world, and especially in emerging markets, have been bingeing on dollar-denominated debt, seduced by the lower interest rates on offer compared with local-currency debt. The stock of dollar debts owed by non-financial borrowers outside America has grown by 50% since the financial crisis, according to the Bank for International Settlements. It now stands at $9 trillion. Emerging markets account for half of that amount, up from a third before the crisis. In China alone, dollar-denominated loans have vaulted from around $200 billion in 2008 to more than $1 trillion now (see article).

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