[Financial Planning for the 100-Year Life] The Strong Dollar, a Global Issue, May Become a U.S. Problem Next Year

Next Year's Growth Rate Forecast Significantly Lowered
Higher Possibility of Dollar Value Decline

[Asia Economy] "The dollar is our currency, but your problem."

This was said by John Connally (U.S. Secretary of the Treasury under the Nixon administration in 1971) to European finance ministers who complained that the U.S. was exporting inflation. There have been two instances when the dollar’s value sharply declined while it was a problem for the U.S. In 1981, the Reagan administration, which came into power with an economic revitalization policy emphasizing tax cuts, was launched. However, the tax cuts caused a ‘twin deficit’ rather than economic revitalization.

By 1985, the U.S. fiscal deficit reached 5% of Gross Domestic Product (GDP), and the current account deficit exceeded 3%. During the adjustment process of these issues, the dollar’s value significantly dropped. Between February 1985 and August 1992, the dollar index composed of major advanced countries’ currencies plummeted by 51%. In particular, the Plaza Accord in September 1985 greatly contributed to lowering the dollar’s value. This agreement was a resolution by the G5 (U.S., U.K., Germany, France, Japan) finance ministers to correct the strong dollar.

The second problem occurred in the 2000s. Since the mid-1990s, the U.S. economy achieved both high growth and low inflation due to productivity improvements from the information and communication revolution. Between 1996 and 2000, the U.S. economic growth rate averaged 4.3% annually, while the consumer price inflation rate was only 2.5%. At that time, this U.S. economy was optimistically called the ‘New Economy’ or ‘Goldilocks Economy,’ and a large bubble formed in the stock market. However, as the information and communication revolution bubble burst, the U.S. share of global GDP fell from 31% in 2001 to 23% in 2008. The dollar’s value also dropped by 40% between February 2002 and March 2008.

The third problem is currently emerging. The U.S. domestic and external imbalances are expanding. During the process of overcoming the 2008 financial crisis and the 2020 COVID-19 economic crisis, the U.S. federal government debt increased significantly. Government debt, which was 62% of GDP in 2007, rose to 231% in 2021.

During the same period, net external debt also surged from 9% to 79% of GDP. This was due to increased consumption driven by low interest rates and a strong dollar. The global credit rating agency Standard & Poor’s (S&P) mentioned these issues in 2011 and downgraded the U.S. sovereign credit rating by one notch; at that time, these figures were 95% and 29% of GDP, respectively.

The outlook for the U.S. economy next year is not bright either. Major institutions, including the International Monetary Fund (IMF), are lowering their global economic growth forecasts for next year, with the U.S. outlook being relatively more pessimistic. In its July World Economic Outlook, the IMF projected the U.S. economy to grow by 1.0% in 2023, which is lower than the Eurozone (1.2%) and Japan (1.7%). Some investment banks, including Bank of America (BOA), expect the U.S. economy to contract next year. This implies that the Federal Reserve (Fed) might cut interest rates at some point next year.

As these U.S. problems become apparent, the probability of the dollar’s value declining for the third time is increasing. According to the real effective exchange rate estimated by the Bank for International Settlements (BIS), as of last July, the dollar was overvalued by 30%. This is even more severe than in 2001, when optimism about the U.S. economy peaked due to the information and communication revolution.

It is only a matter of time before all economic variables, including exchange rates, approach equilibrium. This year, the strong dollar has caused serious pain for the global economy excluding the U.S. After next year, the dollar may become a problem for the U.S. rather than the world.

Kim Young-ik, Professor, Graduate School of Economics, Sogang University