The dollar rose at the end of last week’s trading and at the beginning of this week, at a 13-month high, on the impact of global concerns about the policies of US President-elect Donald Trump towards major economies around the world.
Last Monday, Trump wrote a post on his platform, Truth Social, in which he pledged to impose tariffs on Mexico, Canada, and China on his first day in the White House, scheduled for January 20.
In the face of this type of trade tensions, traders resort to the dollar as a safe haven, and as demand for it increases, its value rises against other currencies, especially emerging market currencies.
Despite the potential tensions on the trade level between Washington and some of its partners, the consequences of the rise of the dollar affect the majority of global economies, including developing countries.
A report by the Institute of International Finance, issued last September, shows that total global debt (individuals, companies, and governments) exceeded $310 trillion by the first half of this year.
1- Dollar centralization
Despite debt reaching unprecedented historical levels, the strong dollar, which reached 107.7 points at the beginning of this week, increases the cost of debt by $100 billion annually for every single point, above 100 points.
The US dollar is considered the global reserve currency, as it constitutes about 58% of the International Monetary Fund’s reserves, according to data issued recently by the Fund.
The dollar also constitutes the currency of 80% of cross-border trade, and it is also the currency of payments in the majority of countries in the world, in addition to national currencies issued by the central banks of those countries.
Therefore, although the US currency enjoys an exceptional position in international trade and financial markets, its strength (its rise in value against other currencies) can lead to wide-ranging economic consequences, especially in light of the great disparity between global economies.
2- The burden of external debt
The financial stability report issued recently by the International Monetary Fund shows that one of the most prominent challenges posed by a strong dollar is the increase in the external debt burden of developing countries.
Many countries borrow in dollars, and therefore the rise in the value of the dollar increases the cost of repaying those debts, because it will push governments to pay more local money in exchange for buying dollars and paying the due installments and interest on those debts.
When the value of the dollar rises and countries are forced to pay more of their local currencies to pay off debts, this at some point leads to the depletion of their local and foreign currency reserves.
Also, a strong dollar raises debt service burdens, forcing governments to reduce public spending or resort to austerity policies that negatively affect economic growth.
In light of a strong dollar, developing countries become more vulnerable to defaulting on their debts, as happened in some previous crises such as the financial crisis in Argentina and the rise in debt service in Egypt.
3- Negative impact on international trade
The World Trade Organization stated in a report last May that the strong dollar is considered one of the most prominent obstacles to the flow of demand for global trade:
- The value of the dollar makes American goods and services more expensive for other countries, reducing the competitiveness of American exports.
- That is, the high cost of dollar-denominated goods reduces the demand for them in global markets, leading to a decline in international trade.
- For countries that rely on dollar-denominated imports, they face rising costs, which exacerbate the trade deficit and increase inflationary pressures.
4- High inflation
- A strong dollar also increases import costs for countries that depend on basic materials such as energy and food.
- In countries with weaker currencies this leads to imported inflation, which raises the cost of living and affects consumers and businesses alike.
- Since oil is priced in dollars, a stronger dollar increases the cost of oil for importing countries, which raises overall fuel and energy prices.
5- Financial and exchange market disturbances
Global financial markets rely heavily on dollar liquidity, so:
- The rise in the value of the dollar leads to major changes in the movement of capital and markets, as investors rush to transfer their money towards dollar-denominated assets in search of higher returns, which leads to the exit of capital from developing economies and the weakness of their currencies.
- A strong dollar causes sharp fluctuations in exchange markets, increasing uncertainty and discouraging investment.
- Central banks are having difficulty providing sufficient liquidity in the US currency, which could lead to stress in financing markets.
