Economists warn that a strong dollar could be a nightmare for the world economy, Fortune reported.
“What is clear is we have this relentless increase in yields, this relentless appreciation of the dollar. They are both bad news for corporates and for the economy,” Mohamed El-Erian, the president of Queens’ College at the University of Cambridge, told CNBC on Monday.
He said that when the entire developing world is "on fire"-and now even in places like the U.K.-the dollar is the currency of last resort for investors.
“The reason why this last leg up in the dollar is happening is because we are the safe haven and one consequence of that is our currency gets stronger,” he said.
This isn't the first time El-Erian has warned of the potentially catastrophic consequences of a rising U.S. dollar.
In a Sept. 6 Washington Post article, El-Erian explained that a strong dollar can be a "mixed blessing." On the one hand, dollar strength helps reduce inflation in the U.S., but at the same time, when the dollar remains steadily strong, it can bankrupt developing countries as the value of their dollar-denominated debt rises sharply.
This is exactly what happened during the Latin American debt crisis of the 1980s. Throughout the 1970s, developing countries in Central and South America accumulated billions of dollar-denominated loans with low interest rates. Then, when the U.S. sharply raised interest rates to fight inflation, beginning in 1982, the cost of debt rose sharply, causing a crisis that, according to the Federal Reserve, plunged Latin America into a "lost decade."
El-Erian warns that a strong dollar can have a number of devastating consequences outside of emerging markets as well. “The longer and higher the dollar soars above the rest, the greater the risk of more prolonged global stagflation, debt problems in the developing world, more restrictions on the free flow of goods across borders, greater political turmoil in fragile economies and greater geopolitical conflicts,” he wrote in his Washing Post op-ed.
El-Erian also noted that the recent strengthening of the U.S. dollar only adds to three key paradigm shifts that have led to an unpleasantly high probability of a global recession.
First, he noted that central banks around the world shifted from supportive to restrictive policies almost simultaneously to confront inflation. Second, global economic growth is slowing considerably, as the world's three most important economies--the U.S., the EU, and China--continue to lose momentum.
And finally, he globalization process, which has helped trigger a deflationary trend worldwide over the past two-plus decades, is now fading because of persistent geopolitical tensions.
In an interview with CNBC, the economist explained that these paradigm shifts have only worsened because of government policies, and called on politicians to stop increasing volatility by hinting at a new plan to cut taxes and spending in Britain.
“It’s not just about the big paradigm shifts,” El-Erian said. “This is about governments and central banks being sources of volatility rather than volatility suppressors. They are adding to the volatility, that’s particularly clear with the government in the U.K., but also in the U.S. with the Fed…it is quite a mess in some of these markets and these are the main markets for the global economy.”
