The rising US dollar is increasing the risk of a serious global economic crisis. The dollar’s rise has triggered economic chaos in Latin America that might spread around the world.
Major Latin American economies are at serious risk for inflation, capital flight, and debt crises because of the stronger US dollar. The Federal Reserve (Fed) is magnifying the risks by raising interest rates in an attempt to prevent inflation in the United States.
The Fed raised short-term interest rates on 13 June in an attempt to cool the economy, Bankrate reported. The Fed is trying to encourage investors to move their money out of stocks and into short-term instruments such as US savings bonds.
Such policies hurt Latin America by diverting investors from Argentine or Brazilian debts to US treasury bonds. The Fed’s moves and the strong dollar make the situation worse by increasing the cost of borrowing money with higher interest rates.
A strong dollar raises the cost of borrowing because most of Latin America’s government debt is in dollars. Nations have less money to pass to pay off more expensive debt as a result of the strong dollar.
Countries like Argentina were having trouble borrowing money before the dollar started rising, economists Joseph E. Stiglitz and Martin Guzman noted. Now they face more expensive debt and severe limits on borrowing.
Argentina in currency crisis – Again
A currency crisis is already underway in Argentina where the peso lost 19% of its dollar value during the first three weeks of May 2018.
Currency depreciation created an economic crisis by making it more expensive for Argentina’s government to borrow money. Consumer prices in Argentina have been rising by 25% a year for some time.
That forced the government to turn to the International Monetary Fund (IMF) for help. The IMF approved a $50 billion financial deal for the country on 5 June.
The deal was needed to prevent an economic meltdown, Argentine President Mauricio Macri claimed. Macri believes Argentina faces a complete economic collapse without the loan.
An IMF loan can backfire and make the situation worse. Austerity policies imposed by a similar IMF loan in 2001 are widely blamed for an earlier Argentine economic crisis that included a 25% unemployment rate.
The IMF’s economic policies are unsustainable and will make long-term economic growth difficult in Argentina, Stiglitz and Guzman predicted. Those policies are also politically unpopular.
Macri’s IMF agreement sparked mass protests in Buenos Aires. Future measures like the elimination of utility subsidies may spark even more unrest.
The Argentine stock market has displayed little faith in Macri’s policies. The country’s benchmark MerVal stock index fell by 8.8% on 27 June, Reuters reported. Measures such as increasing bank reserve requirements, and lowering caps on foreign currency holdings, failed to reassure investors.
The stock selloff caused the Peso to fall by 1.2% on 27 June. A US dollar was worth 27.43 Argentinian pesos at the end of trading on that day.
That erased the gains made during Macri’s administration, by taking the Peso back to where it was when Macri took office, Reuters pointed out. The Peso was trading at 72.43 to the dollar in September 2015.
Brazil battling inflation
Like Argentina, Brazil is battling both inflation and rising political unrest.
Brazil’s National Monetary Council lowered its inflation target for 2021 to 3.75%. That number is above the 2018 inflation rate of 3.5% but below the projected 2021 rate of 4.05%, Statista data indicates.
The Council acted after a truckers’ strike drove inflation to a two-year high in mid-June. Inflation rose to 3.68% because of product shortages created by the strike. Inflation had fallen to just 2.86% at the end of May.
Inflation controls are part of Brazil’s effort to attract more international investment. Inflation is a politically sensitive issue in Brazil, where hyperinflation made life miserable for the middle and working classes for decades.
Like Argentina, Brazil has been plagued by a sluggish economic recovery that is heavily dependent on foreign investments and debts. That economy is now threatened by deflation of food prices.
Both Argentina and Brazil are heavily dependent on agricultural exports. Food prices are suffering depreciation because of a record harvest.
The escalating trade war between the United States and its trading partners has the potential to increase food deflation. Large amounts of agricultural products might get dumped on the international market at low prices if they cannot be sold in traditional markets.
That can make Argentine and Brazilian agricultural products less competitive on the global market and weaken their economic positions. Beneficiaries of this situation would include food importers like the United Kingdom, Japan, and China.
Rate hikes and inflation risks are worldwide
The risk from inflation, Fed interest rate hikes, depreciation, and the strong dollar extends worldwide.
Moody’s increased the credit risk rating for several emerging market nations on 27 June – Ghana, Mongolia, Pakistan, Sri Lanka, Turkey, and Zambia joined Argentina on Moody’s risk list.
“Countries with large current account deficits, high external debt repayments, and substantial foreign-currency government debt are most exposed to the impact of a stronger US dollar,” Moody’s Global Managing Director of the Sovereign Risk Group Alastair Wilson told the press.
The strong dollar is a burden on countries with low-foreign exchange reserves, Moody’s reported. Moody’s analysts believe countries with higher exchange reserves such as Chile, Colombia, Malaysia, and Indonesia might weather the storm.
Risk analysts need to pay close attention to the Federal Reserve’s actions. The policies of America’s central bank can generate inflation and economic chaos around the globe. The side effects of inflation include political unrest.