If recent market tumult serves any constructive purpose, it may be as a reminder that U.S. economic clout remains very formidable. From the collapse in the British pound to Japan's once-in-a-generation market intervention, alarm in South Korea about its southbound currency and the worrying swoon in the Chinese yuan, the underlying driver is an epic rally in the dollar.
The hyper-charged greenback is the product of aggressive interest-rate hikes by the Federal Reserve and the promise of more to come. It's not just that rates are marching higher—inflation requires it—that's undercutting almost every other country and making a global recession more likely. The Fed's unwillingness to step back from big increases in borrowing costs is trapping policymakers around the world in a fire-fighting mentality that’s unlikely to end well.
Only the Fed can restore some stability. The question is whether Chair Jerome Powell can get that “oasis” feeling. That's a reference to a few lines in a speech by Alan Greenspan in early September 1998, a time of enormous financial upheaval outside the U.S. America's economy was enjoying one of the longest expansions in history. The Fed boss at the time fretted that fissures in the global economy threatened that prosperity.
His talk scheduled for Sept. 4 at the University of California at Berkeley was long planned and Greenspan had intended to talk about domestic productivity gains and technology. But as the date drew near, he couldn't pretend the world could be shut out, Greenspan recalled in his book The Age of Turbulence: Adventures in a New World. Russia had defaulted the previous month, the Asian financial crisis wasn't yet quelled. Days earlier, Malaysia imposed capital controls and pegged its currency. There was great fear that other besieged countries, bristling at tough conditions on loans from the International Monetary Fund, would follow suit. Latin American markets sagged and would soon need rescue.
Greenspan wanted to prick isolationism. “It is just not credible that the United States can remain an oasis of prosperity unaffected by a world that is experiencing greatly increased stress,” he said. Markets took his remarks to imply the Fed was preparing to cut rates, which the central bank did shortly after. That isn't feasible today: inflation far exceeds the Fed's 2% target. A plethora of Fed commentary and projections—hallmarks of the post-Greenspan days at the helm—point unambiguously to further hikes in borrowing costs. But the Fed has an obligation to try to restore some sobriety to markets.
Why has 75 basis points become the new normal? Prior to this year, steps of that magnitude were considered unusual, almost extreme. Now, the Fed has encouraged investors to assume there will be a fourth consecutive hike of that size in November. That's prompted over-the-top bets on rate increases of at least 100 basis points at the next Bank of England meeting, and strenuous efforts by European Central Bank President Christine Lagarde to prevent the same expectations taking root in the euro zone.
Because of the power of the dollar as the world's primary reserve currency, what the Fed does and how U.S. officials frame their policy intentions matters enormously. The resulting economic and financial ructions in the rest of the world, ultimately, harms American interests. Japan's purchases of yen last Thursday can be viewed as the product of ultra-low rates and a determination to keep them. That doesn't mean it can be dismissed. Tokyo spent an estimated $25 billion that afternoon, more than the entire period of supporting its currency in 1998.
The Bank of Korea was one of Asia's first rate hikers and has been nudging up the price of money consistently. That hasn't stopped a cratering of the won. Seoul is intervening to cushion its fall and has gone as far as asking dealers to report on demand for dollars on an hourly basis. Even an exchange rate as heavily managed as the Chinese yuan has slipped to a 14-year low. The Reserve Bank of Australia keeps saying rates are not on a “pre-set path,” but then gets forced into consecutive half-point raises. The only surprise about this week's big cut to global growth forecasts by the OECD was that it wasn't bigger.
Fed speakers this week haven't offered much room for encouragement. They have stressed the need to keep lifting rates to restore price stability. “We have increased the policy rate substantially this year and more increases are indicated,” St. Louis Fed chief James Bullard said Tuesday. Fine as far as it goes. Nobody is actually advocating they stop, merely that there be more serious acknowledgment that the Fed doesn't operate in a vacuum. Would such a concession be interpreted as a dovish pivot and is that fear driving the uncompromising public line?
Officials should dwell on how they can commit to quelling inflation but do so in a way that doesn't wreck the global economy. “We fear the Fed remains fixated on spot inflation/labor conditions and stuck in a hamster wheel of 75 bp hikes,” Evercore ISI analysts Krishna Guha and Peter Williams wrote in a note Tuesday. “Until this changes, it's hard to see a way out.”
Like it or not, the Fed is the clock by which the global monetary cycle is set. In his first Jackson Hole address as Fed chair in 2018, Powell praised Greenspan's overall approach to managing the economy. He could do worse than pay a visit to Berkeley.
Daniel Moss is a Bloomberg Opinion columnist covering Asian economies. Previously, he was executive editor of Bloomberg News for economics.