Who Gets Hurt by a Strong Dollar?

The Federal Reserve Open Market committee meets on December 16 and will most likely raise interest rates for the first time since June of 2006. Higher interest rates will tend to drive the USD higher against other currencies. One by product of a stronger dollar is that US products become more expensive in foreign markets which tend to hurt US exports and exporters. But, who gets hurt by a strong dollar as much or more than the U.S.A.? Bloomberg Business contends that a strong dollar hurts China more than the U.S. This has to do with currencies that are pegged to the dollar.

The biggest loser from a stronger dollar may be China, not the U.S. And that’s why some economists predict the Asian nation will loosen its currency’s link to the greenback and allow the yuan to depreciate.

The People’s Bank of China took what may be a small step in that direction on Wednesday when it cut the currency’s reference rate to 6.4140 per dollar, its weakest level since 2011.

The Asian nation has tethered the yuan, for the most part, to the dollar in order to enhance financial stability. That means as the dollar advances against most currencies across the world on expectations of rising U.S. interest rates, the yuan does, too. China suffers more, though, because its slowing economy is almost twice as dependent on trade.

“It’s a problem,” said Yukon Huang, a senior associate at the Carnegie Endowment for International Peace in Washington and a former World Bank country director for China. “Excessive appreciation at a time when the economy is sinking is a bad thing.”

China’s economy is slowing. It has a dangerous real estate bubble and excessive debt. The Communist managers in China have a tough time ahead managing a transition to a more market driven and more locally open economy. Because China still depends largely on exports for its success, who gets hurt by a strong dollar is China and the RNB. Who else does this apply to?

Currencies Pegged to the USD

Investopedia writes about exchange rates pegged to the U.S. dollar. The article provides a bit of insight into why and how currencies are pegged to the USD. It should be noted that China, for example, does not officially peg to the USD but in fact they do!

Most of the Caribbean islands (Aruba, Bahamas, Barbados, and Bermuda, to name a few), peg to the U.S. dollar because their main source of income is derived from tourism paid in dollars. In Africa, many countries peg to the euro. Dijibouti and Eritrea, pegged to the U.S. dollar, are the exceptions. In the Middle East, may countries (including Jordan, Oman, Qatar, Saudi Arabia, and United Arab Emirates) peg to the U.S. dollar for the stability-the oil-rich nations need the United States as a major trading partner for oil. In Asia, Macau and Hong Kong fix to the U.S. dollar. While it does not officially peg its currency, the Chinese yuan, to the U.S. dollar, it does manage it (some say manipulate it) to benefit its manufacturing and export-driven economy.

Nations like Saudi Arabia benefit from a stronger dollar because the oil they export is priced in dollars and their currencies buy more when the dollar is stronger. Panama does not export much and charges for passage through the canal in USD. Hong Kong might be hurt because a stronger dollar will hurt their exports in competition with nations like Indonesia, Thailand or Vietnam. It should be noted that although many currencies do not peg to the USD they follow the example of China and only allow movement within a specified trading range every day. These nations, like China, are affected by a stronger dollar.

Is a Higher Dollar Already Priced In?

The markets have had a year and a half to get ready for a USD rate increase and during that time the USD has gone up 24% against a basket of currencies. Considering that the Fed will raise rates minimally just how much higher will a rate increase send the USD? Or will it be a matter of buy on the hype and sell on the news in which case the dollar could correct when the Fed announces a rate increase.