Strong US dollar fuels fears of worst currency crash since 1997

The staggering rise of the US dollar, which has hit one record after another, is raising fears of a currency crash of a severity that has reverberated around the world since the Asian financial crisis of 1997.

The Federal Reserve’s rapid, sharp rate hikes and the relative health of the U.S. economy have led investors to plunge into the dollar, pushing the dollar to strengthen the British pound, Indian rupee, Egyptian pound and South Korean won and others have been driven to unknown depths. .

“The moves are definitely getting extreme,” Jefferies’ Brad Bechtel said, warning that exchange rates could fall further, creating a “serious situation.”

Most other major central banks are also tightening monetary policy vigorously to curb inflation, but so far the measures have not helped stabilize the currency market, nor have Japan’s direct intervention to support the yen last week.

Many fear the same will be the case with the Bank of England’s plan announced Wednesday to conduct emergency government bond purchases to support the pound.

“We have our doubts that the BoE’s plan will be the silver bullet to kill all the fear that has put pressure on the pound… as the plan is not sustainable,” Briefing.com’s Patrick O’Hare said.

Others, especially emerging markets, are even worse off. The Pakistani rupee has lost 29 percent of its value against the US dollar in the past year and the Egyptian pound has weakened 20 percent.

Those countries, and others like Sri Lanka and Bangladesh that “benefited from cheap and abundant liquidity” when interest rates were low during the pandemic, “are all suffering from tighter global liquidity,” said Win Thin, head of currency strategy at BBH Investor. . Services.

“The countries with the weakest fundamentals will likely be tested first, but others can join them,” he warned.

Those countries depend on imported oil and grain, which has pushed prices up, widened their trade deficits and fueled inflation, and that means huge blows to their currencies.

The appreciation of the US currency has exacerbated the problem, as many commodities are denominated in dollars.

Already in a vulnerable position, Pakistan was hit by historic floods in August, prompting the government to discuss debt restructuring.

“The financial system is under severe strain right now. And it’s only a matter of time until there’s a bigger crisis somewhere in the world,” warns ForexLive’s Adam Button.

US Treasury Secretary Janet Yellen said earlier this week that she has seen no signs of “disorderly” developments in financial markets during the interest rate hikes.

For countries like Taiwan, Thailand or South Korea, which also depend on energy imports, China’s zero-covid policy has caused their exports to this important trading partner to plummet.

Larger economies such as China and Japan have contributed to the turbulence in the foreign exchange market in recent weeks. The Japanese yen fell to its lowest level in 24 years, while the Chinese yuan hit its weakest in 14 years.

Fears of destabilization evoke memories of the Asian financial crisis of 1997, which was caused by the devaluation of the Thai baht.

Malaysia, the Philippines and Indonesia followed suit, which panicked foreign investors and led to massive capital outflows, sending several countries into severe recession and South Korea on the brink of bankruptcy.

At the time, the baht’s collapse was related in part to its fixed parity with the dollar, which forced the Thai government to support its currency, depleting its foreign exchange reserves, which was unsustainable in the face of market forces.

Argentina was eventually forced to give up its peg to the dollar and defaulted in late 2001 – the largest government debt in history.

Erik Nelson of Wells Fargo said this is a key difference between 2022 and 1997.

“Now there are not many fixed exchange rates,” he said. “I’m honestly more concerned about developed markets right now.”

Lebanon, one of the few to still peg its currency to the greenback, announced a drastic devaluation on Thursday, pushing the country’s pound from its previous fixture of 1,507 to 15,000 to the dollar.

In contrast, in the United States, where inflation has risen to its 40-year high, “the Fed views a strong dollar as a blessing,” DailyFX’s Christopher Vecchio said, noting that it helps “isolate the economy from increased price pressures.” “. ‘

A strong currency means the country pays less for its imported products.

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