The American magazine "Foreign Affairs" published an article by the American economist Barry Eichengreen calling on central banks to diversify their reserves and transactions away from the risks of the strong dollar and towards the currencies of the euro area, China and smaller economies.
Doing so would make countries less vulnerable to the decisions of a single central bank, he said, adding that a rising dollar exacerbates painful debt sustainability problems for dozens of low- and middle-income countries, especially since much of the corporate debt in such countries is in the hands of foreign investors. denominated in dollars.
vicious circle
The writer explained that debt becomes more expensive when the dollar is strong, noting that even when the debt is in the local currency, the depreciation of the exchange rate against the dollar can cause problems.
He pointed out that US financial companies, which see themselves exposed to losses on these foreign investments, are withdrawing from emerging market assets, which puts additional downward pressure on the value of foreign currencies in a vicious circle.
The writer said that global commodity prices are denominated in dollars, so the cost of imports rises when the value of local currencies decreases against the American currency, and this dynamic - according to the writer - leads to inflation, and for this reason an increasing number of central banks intervene in the foreign exchange market, using their reserves in dollars. To buy the local currency, and thus support it.
The writer added that most of the US treasury bonds sold by central banks end up flooding the US financial markets, which boosts the supply of these bonds and pushes the dollar to strengthen in reverse.
Interventions in the foreign exchange market are not recommended
The writer says that interventions in the foreign exchange market by central banks in emerging markets are often seen as a sign of weakness, making them a vehicle for further economic and financial turmoil.
He adds that the Federal Reserve (the US central bank) will not abandon raising interest rates to counter inflation, and instead, it can activate the swap lines through which it provides dollars to foreign central banks.
But these swap lines - according to the author - are small movements in relation to the size of global financial markets, so if foreign central banks use them to conduct more intervention in the exchange market, the dollars provided according to this mechanism will return to the United States.
coordinating efforts
The author cautions that coordinated intervention - such as the 1985 Plaza Accord in which the United States and other governments agreed to simultaneously sell dollars in exchange for foreign currencies to devalue the dollar - is not currently expected.
It took years of diplomacy at the time to reach an agreement between France, Germany, Japan, the United Kingdom, and the United States, and today the group of relevant countries that should engage in this type of intervention is much larger than before.
He believes that the effective completion of the agreement requires cooperation between the United States and China at a time when the differences between the two countries are far apart, and says that the implementation of such an agreement will require the Federal Reserve to reduce interest rates.
The writer adds, "Given the importance that the Federal Reserve and the US Treasury attach to reducing inflation, the United States is not ready to accept such cuts."
The writer believes that the only reliable way for countries to support their currencies against the dollar is to raise interest rates, which encourages capital flows towards their asset markets, but he certainly adds that the situation remains uncomfortable in the current circumstances, as interest rates rise and economic growth weakens.