Strong Dollar False Fears Are Back

Whatever the dollar is doing lately, you can be sure many pundits don’t like it. When it is weak, people hate it—it makes America import inflation. And when it is strong, people still hate it. The latter is the case now, with fears centering on the strong dollar’s alleged dangers for Emerging Markets (EM), whose currencies are at multi-year lows versus the greenback. Officials in South Korea, India, Indonesia and Malaysia are all jawboning about a too-strong dollar and intervening in currency markets, with some starting to act. This regularly happens when EM currencies get weak, in large part because sentiment remains scarred from the late 1990s’ Asian Currency Crisis. But it isn’t the big economic risk headlines make it out to be.

For one, now isn’t like the late 1990s. Then, Emerging Asia had high levels of dollar-denominated debt, which they financed cheaply by maintaining currency pegs. When several currencies came under pressure, central banks burned through reserves to defend the pegs, then had no choice but to drop them. The currencies then plummeted, with the sudden devaluations leading to financial crises and IMF bailouts in South Korea, Indonesia and Thailand. Malaysia and developed-market Hong Kong came under severe pressure. But in all cases, it was the fallout from defending and discarding currency pegs that caused havoc—not just the dollar’s swings.

That isn’t an issue today. All but Hong Kong have floating currencies, and their foreign exchange reserve war chests are far larger. Talk of intervention centers more on curbing volatility than on defending certain values. Not that intervention is riskless, but these nations don’t look poised to deplete their reserves in short order.

As for talk of weak EM currencies disrupting trade flows and damaging global economic growth in the process, we doubt it. The dollar was stronger versus a broad currency basket in late 2022 than it is now, and we don’t recall some massive trade crisis then. Rather, weak currencies create winners and losers, which is why a lot of businesses hedge for them. On the plus side, they make export revenues worth more when converted from dollars (or whatever) back to the home currency. That enables exporters to cut prices overseas to gain market share or reap larger profits from currency conversion. The downside is a weak currency makes imported labor, components and raw materials (including energy) more expensive, but it all tends to even out over a cycle. And, again, businesses hedge for currency swings, mitigating a lot of impact at the company-specific level.

Those concepts might be abstract and theoretical, but real-world facts aren’t. Emerging Asian currencies have been weak for a couple of years now. Yet their economies are growing nicely. Indian GDP is among the world’s fastest even when you strip out some of the idiosyncratic items that skew it. After a brief contraction at 2022’s end as household spending hit a speedbump, South Korean GDP rebounded in early 2023 and grew 2.5% annualized three straight quarters through Q4 2023.^[i] Indonesian GDP grew 5.0% last year.^[ii] Malaysia grew 3.7%, which is slow only in comparison to 2022’s 8.7% jump.^[iii] Currency markets aren’t screaming that these nations are in trouble. Rather, weakness is the logical result of these nations’ maintaining swift money supply growth while US money supply was contracting. Yes, the price of money, too, is all about supply and demand.

Lastly, there is no guarantee Emerging Asian currency weakness persists indefinitely. Fed rate cuts, whenever they happen, could alter the all else equal, money flows to the highest-yielding asset calculus. The geopolitical and market jitters that seem to have sparked a flight-to-safety mentality should ease in time, as they typically do.

So we suspect this will go the way similar EM currency fears went in 2013, 2015 and 2018: lots of fear and little fallout. Those bouts proved to be bricks in the long 2009 – 2020 bull market’s wall of worry. This latest round should do the same, especially with so much attention heaped on it.