Strong Dollar Is ‘Wrecking’ Asia’s 2023 Hopes, Too

When lexicographers make lists of the top phrases of 2022, the “wrecking ball” moniker economists attached to the dollar is sure to rank prominently.

A dominant theme of the first 10-plus months of the year is how the surging U.S. currency is upending Asia’s trajectory. While that’s true of emerging markets everywhere, trade-reliant Asia is uniquely at risk. This region also has the biggest stockpiles of U.S. Treasury securities, raising the stakes.

Episodes of extreme dollar strength tend to end badly for Asia. The most obvious episode was the region’s 1997-1998 financial crisis. The crash was precipitated by the Federal Reserve’s aggressive 1994-1995 tightening cycle.

At the time, the dollar’s rally acted like a ginormous magnet for capital from all corners of the globe. It morphed the global economy into a zero-sum game, with dollar assets enjoying the ultimate fear-of-missing-out trade.

That left Thailand, Indonesia, South Korea and others starved for capital, and desperately so. Over time, currency pegs to the dollar became impossible to defend. Currency strains also pushed Malaysia and the Philippines to the brink.

The worry is that this dynamic is unfolding again. And at a moment when China is stumbling—unlike in the late 1990s.

Back then, the thing that panicked officials at both the U.S. Treasury Department and International Monetary Fund the most was China weakening the yuan. That would’ve surely kicked off a new round of competitive devaluations and added fresh fuel to the fire.

Today, China is spooking global markets for a very different reason. It isn’t manipulating its currency, so much as investors are voting with their feet and leaving as Asia’s biggest economy weakens.

Making things worse, its troubles are largely self-inflicted. Along with the draconian “zero-Covid” Beijing just can’t quit, the regulatory crackdown on Big Tech is working at cross purposes with President Xi Jinping’s pledges to modernize China Inc.

The strong dollar is luring capital away from China at the worst possible moment for Xi’s government. This dynamic is hitting mainland stock bourses and boosting bond yields. The yuan’s nearly 13% drop this year makes it harder for mainland companies to may dollar-denominated debt payments, increasing default risks.

With commodity prices surging, Asia is increasingly engaging in a “reverse currency war.” The region spent the last 30 years weakening exchange rates to boost exports. Now, the Fed’s rate hikes have officials from Beijing to Jakarta struggling to support currencies.

“The dollar’s advance has run out of steam, but that doesn’t mean it is over,” says analyst Edward Moya at OANDA.

Trouble is, the zero-sum dynamic is back. The skyrocketing dollar is now posing challenges to advanced and emerging economies alike.

“We appear to be entering the third dollar boom period in the past 50 years,” says Paul Gruenwald, global chief economist at S&P Global Ratings. “There is no easy solution. Passivity endangers inflation targets and credibility, rate rises risk lower output and employment, intervention is likely to burn through precious reserves.”

Gruenwald notes that the 1980s solution—bold global coordination—required lots of political capital from Washington and willing partners around the globe. A repeat of the 1985 deal to weaken the dollar—the “Plaza Accord”—probably isn’t in the cards. When the Bank of Japan intervened last month to support the yen, it acted alone. And it failed.

One reason the dollar trade is so one-sided is a dearth of obvious alternatives. The euro is plodding along at 20-year lows as European growth wanes. The yen, meantime, is down 27% this year as the BOJ keeps its foot on the monetary stimulus accelerator.

The British pound plunged toward parity to the dollar as Prime Minister Liz Truss botches economic policy out of the gate. Last week, Fitch Ratings downgraded the UK’s sovereign debt outlook to negative from stable.

Despite China’s status as the globe’s top trading nation, the yuan isn’t quite ready for prime time. The lack of full convertibility also limits the yuan’s utility as a potential reserve currency.

China also is squandering trust among global investors. Credit growth there recovered faster than anticipated last month as Beijing increased infrastructure investment. Yet indications are that Xi is sticking with his growth-killing Covid lockdowns.

Ironically, the more the Fed’s rate hikes shake up world markets—and the wrecking ball swings—the more global investors are hoarding dollars. In its most recent World Economic Outlook, the International Monetary Fund warned that “in short, the worst is yet to come, and for many people 2023 will feel like a recession.”

The IMF pruned its forecast for 2023 growth by 0.9 percentage points to 2.7%. “Persistent and broadening inflation pressures have triggered a rapid and synchronized tightening of monetary conditions, alongside a powerful appreciation of the U.S. dollar against most other currencies,” IMF economists observe.

The risks of volatile capital flows and debt crises are increasing as this giant wrecking ball swings anew.