The fact that bigger emerging markets have so far largely withstood higher U.S. interest rates and the stronger dollar has been something of a pleasant surprise. But how long they will continue to do so if the Fed pursues an aggressive tightening path remains to be seen, particularly if commodity prices simultaneously fall further (as my Harvard colleague Jeffrey Frankel has warned) and the U.S. and Europe slide into recession, on top of the slowdown in China.
In the near term, a buoyant dollar will affect America less severely than its trading partners, mainly because U.S. trade is almost entirely invoiced in dollars. But a persistently stronger dollar will have a longer-term domestic impact, as the U.S. will become a relatively more expensive place to produce. It won’t help foreign tourism, still sharply down from 2019.
Might the dollar’s recent surge against other major currencies go into reverse? To be sure, some previous big run-ups in the dollar’s value, including in the mid-1980s and the early 2000s, were eventually followed by sharp declines. But, again, exchange rates are notoriously difficult to predict, even on a one-year horizon. A further 15% fall in the euro and the yen against the U.S. currency is entirely possible, particularly if geopolitical frictions take another turn for the worse. The only thing that can be said with certainty is that the period of extraordinarily quiescent major-currency exchange rates, beginning back in 2014, is now history.
Kenneth Rogoff, Professor of Economics and Public Policy at Harvard University and recipient of the 2011 Deutsche Bank Prize in Financial Economics, was the chief economist of the International Monetary Fund from 2001 to 2003. He is co-author of This Time is Different: Eight Centuries of Financial Folly (Princeton University Press, 2011) and author of The Curse of Cash (Princeton University Press, 2016).