By Jomo Kwame Sundaram
KUALA LUMPUR, Malaysia, Jul 26 2023 – Currency values and foreign exchange rates change for many reasons, largely following market perceptions, regardless of fundamentals. Market speculation has worsened volatility, instability and fragility in most economies, especially of small, open, developing countries.
US Fed pushing up interest rates
For no analytical rhyme or reason, US Federal Reserve Bank (Fed) chairman Jerome Powell insists on raising interest rates until inflation is brought under 2% yearly. Obliged to follow the US Fed, most central banks have raised interest rates, especially since early 2022.
Jomo Kwame Sundaram
The US dollar or greenback’s strengthening has been largely due to aggressive Fed interest rate hikes. Undoubtedly, inflation has been rising, especially since last year. But there are different types of inflation, with different implications, which should be differentiated by nature and cause.
Typically, inflationary episodes are due to either demand pull or supply push. With rentier behaviour better recognized, there is now more attention to asset price and profit-driven inflation, e.g., ‘sellers inflation’ due to price-fixing in monopolistic and oligopolistic conditions.
Recent international price increases are widely seen as due to new Cold War measures since Obama, Trump presidency initiatives, COVID-19 pandemic responses, as well as Ukraine War economic sanctions.
These are all supply-side constraints, rather than demand-side or other causes of inflation.
The Fed chair’s pretext for raising interest rates is to get inflation down to 2%. But bringing inflation under 2% – the fetishized, but nonetheless arbitrary Fed and almost universal central bank inflation target – only reduces demand, without addressing supply-side inflation.
But there is no analytical – theoretical or empirical – justification for this completely arbitrary 2% inflation limit fetish. Thus, raising interest rates to address supply-side inflation is akin to prescribing and taking the wrong medicine for an ailment.
Fed driving world to stagnation
Thus, raising interest rates to suppress demand cannot be expected to address such supply-side driven inflation. Instead, tighter credit is likely to further depress economic growth and employment, worsening living conditions.
Increasing interest rates is expected to reduce expenditure for consumption or investment. Thus, raising the costs of funds is supposed to reduce demand as well as ensuing price increases.
Earlier research – e.g., by then World Bank chief economist Michael Bruno, with William Easterly, and by Stan Fischer and Rudiger Dornbusch of the Massachusetts Institute of Technology – found even low double-digit inflation to be growth-enhancing.
The Milton Friedman-inspired notion of a ‘non-accelerating inflation rate of unemployment’ (NAIRU) also implies Fed interest rate hikes inappropriate and unnecessarily contractionary when inflation is not accelerating. US consumer price increases have decelerated since mid-2022, meaning inflation has not been accelerating for over a year.
At least two conservative monetary economists with Nobel laureates have reminded the world how such Fed interventions triggered US contractions, abruptly ending economic recoveries. Although not discussed by them, the same Fed interventions also triggered international recessions.
Friedman showed how the Fed ended the US recovery from 1937 at the start of Franklin Delano Roosevelt’s second presidential term. Recent US Fed chair Ben Bernanke and his colleagues also showed how similar Fed policies caused stagflation after the 1970s’ oil price hikes.
De-dollarization?
However, the US dollar has not been strengthening much in recent months. The greenback has been slipping since mid-2023 despite continuing Fed interest rate hikes a full year after consumer price increases stopped accelerating in mid-2022.
Many blame recent greenback depreciation on ‘de-dollarization’, ironically accelerated by US sanctions against its rivals. Such illegal sanctions have disrupted financial payments, investment flows, dispute settlement mechanisms and other longstanding economic processes and arrangements authorized by the World Trade Organization, International Monetary Fund and UN charters.
Even the ‘rule of law’ – long favouring the US, other rich countries and transnational corporate interests – has been ‘suspended’ for ‘reasons of state’ due to economic warfare which continues to escalate. Unilateral asset and technology expropriation has been justified as necessary to ‘de-risk’ for ‘national security’ and other such considerations.
Horns of currency dilemma
For many monetary authorities, the choice is between a weak currency and higher interest rates. With growing financialization over recent decades, big finance has become much more influential, typically demanding higher interest income and stronger currencies.
Central bank independence – from the political executive and legislative processes – has enabled financial lobbies to influence policymaking even more. For example, Malaysia’s household debt share of national output rose from 47% in 2000 to over four-fifths before the COVID-19 pandemic, and 81% in 2022.
There is little reason to believe recent exchange rates have been due to ‘economic fundamentals’. Currencies of countries with persistent trade and current account deficits have strengthened, while others with sustained surpluses have declined. Instead, relative interest rate changes recently appear to explain more.
Thus, both the Japanese yen and Chinese renminbi depreciated by at least six per cent against the US dollar, at least before its recent tumble. By contrast, British pound sterling has appreciated against the greenback despite the dismal state of its real economy.
IPS UN Bureau
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