Across the globe, interest rates are rising, inflation continues, and many currencies are losing their value against the dollar. Tuesday, the director-general of the World Trade Organization said she thinks “we are edging into” a global recession. But despite its weak economic outlook, the United States is expected to grow faster than its wealthy peers — and high interest rates make U.S. assets more attractive to global investors.
As far as the rest of the world’s concerned, that might not exactly be a good thing.
“The Fed hike plus the dollar strength have priced a set of emerging and frontier markets out of the dollar bond market, and they are facing a steady a buildup of pressure,” explained Brad Setser, a senior fellow at the Council on Foreign Relations. “That has been generating significant stress.”
The rise in the value of the dollar generates a series of second-order economic effects. For countries and companies with large dollar-denominated debts, this means repayment will be more difficult.
Governments and central banks in much of the rest of the world face twin challenges: sluggish economic growth and high inflation. By using the tool at the ready — steep interest rate hikes — central banks are deliberately sacrificing the former to cure the latter. At the same time, especially in Europe, high energy costs are their own independent damper on economic activity, while in poorer countries, debts have become increasingly difficult to service.
The president of World Bank recently warned that “global growth is slowing sharply.”
The world’s currencies are falling against the dollar
This summer, for the first time in over two decades, the euro fell below the dollar while the British pound dropped to as low as $1.03 on Monday. The country’s new government has set out a massive commitment to cap consumer energy prices as well as cut taxes, increasing the country’s deficit. “Global markets have balked at financing it, hence rising interest rates and a much weaker pound,” Setser said.
But the real pressures fall on poorer countries. Developing nations have not only faced the real cost of essentials like oil, gas and fertilizer rising since the onset of the pandemic, but when the dollar rises, the price increases are magnified as these goods, especially oil, tend to be priced in dollars. After Sri Lanka found it nearly impossible to import fuel this summer, its government was overthrown.
A recent World Bank report concluded that the world today resembles past moments when global downturns have occurred.
“These developments do not augur well for the likelihood that a global recession can be avoided,” according to the report, “because there was significant weakness in global growth during the year preceding every global recession since 1970, which all occurred concurrently with a recession in the United States.”
Other countries that don’t face the prospect of unpayable dollar debts can still feel effects from an appreciating U.S. currency. Japan’s central bank was forced to buy yen for the first time since the 1990s in order to maintain the value of the yen. Japan has held on to its low interest rate policy despite the Fed and other rich central banks hiking, pushing the value of the yen down relative to the dollar.
“In a sense, the most dramatic aftershocks have come in a place that maybe wasn’t expected. The dollar-yen movements have been quite substantial,” said Setser.
Economic growth looks bleak in Europe
Among rich countries, Germany especially is positioned for a tough year in 2023, with economists at the Kiel Institute recently declaring its “economy is in a downward spiral.” Dependent on Russian gas to power its export-oriented economy, Germany is perhaps an extreme example of what faces much of the rich world in the coming year though, in some ways, also a representative one.
While the Organization for Economic Co-operation and Development still expects the global economy to grow in 2023, it has slashed its projections for growth in the United States to 0.5 percent and in countries that use the euro to 0.25 percent.
The OECD predicts an outright economic contraction in Germany next year. And German economists are no less pessimistic. The combination of more expensive electricity and natural gas will hamper the ability of German consumers to spend, while “the slowing world economy will dampen not only exports but also investment activity,” according to a report from the Kiel Institute. “As a result, the German economy will slide into recession once again, at a time when it was just recovering from the pandemic-related crisis.”
In Britain, the Bank of England has said that the economy is likely in a recession already. The Federal Reserve’s outlook for economic growth in this year and the next has steadily been written down, with the latest forecast of essentially flat growth in 2022 and close to 1 percent growth in 2023.
The world is raising interest rates together — sharpening the prospect of a global recesison
With the exceptions of China, Turkey and Russia, much of the world is raising interest rates together.
“Because they are highly synchronous across countries, they could be mutually compounding in tightening financial conditions and steepening the global growth slowdown,” World Bank official Ayhan Kose said earlier this month. But economic growth and tighter monetary policy do not affect every country equally. As the Federal Reserve has hiked rates, the dollar has gained in value compared with other currencies.
Zambia recently accepted a bailout from the International Monetary Fund after defaulting on some of its debt in 2020. The southern African country was battered both by the economic downturn of 2020 but also by the hike in fertilizer prices following Russia’s invasion of Ukraine. The exchange rate for its domestic currency, kwacha, with the dollar deteriorated from just over 10 kwacha to the dollar to 20.
“Many countries — especially the poorest — cannot borrow in their own currency in the amount or the maturities they desire,” a World Bank economist explained in August. “Lenders are unwilling to assume the risk of being paid back in these borrowers’ volatile currencies. Instead, these countries usually borrow in dollars, promising to repay their debts in dollars — no matter the exchange rate. Thus, as the dollar becomes stronger relative to other currencies, these repayments become much more expensive in terms of domestic currency.”
Thanks to Lillian Barkley for copy editing this article.