Davos panellists highlight risks posed by strong dollar

The strength of the US dollar is playing on the minds of policymakers, according to a panel of experts appearing at the World Economic Forum in Davos, Switzerland, today (January 17).

In a discussion about how policymakers should navigate the ever-changing financial environment, one hot topic was how the dollar would affect the pace at which the US Federal Reserve raises interest rates.

Carmen Reinhart, professor of international financial systems at Harvard Kennedy School, said she thought it was highly unlikely the Fed would quicken its pace of normalisation, given the recent currency fluctuations.

"Currently, the strength of the US dollar would be a factor which would argue for a more moderate pace of normalisation in the US," she said.

Appearing alongside Reinhart was former Deutsche Bundesbank president Axel Weber, who also said the Fed would have to slow the pace of its normalisation process in order to accommodate the strengthening currency.

"It is likely the Fed will have to stop raising rates and have to level off... They will have to face the fact the recovery cycle will need to be delayed," he said.

However, Weber explained dollar appreciation cycles normally only last around 70–75 months and usually correct themselves: "The current dollar appreciation has lasted 65 months, during which time it has appreciated 30%... An inherent correction will occur in about 10 to 15 months' time."

Despite this possible correction, Weber stressed the Fed will most likely "come to the end of their tightening cycle at a much lower rate than first expected".

Emerging market crisis

Panellists were also concerned about the effects of the strengthening dollar internationally. David Rubenstein, chief executive of private equity firm The Carlyle Group, said the US central bank will now have to take into account the impact of the rise in the dollar not only because of its domestic impact, but also its effect on emerging markets (EMs).

"The currency has gone up so much that we run the risk of another Mexican crisis – where the dollar is so strong, people who have borrowed in dollars are not able to repay the debt in local currency," he said.

There is currently around $4.5 trillion of dollar-denominated debt held by EMs, according to Rubenstein: "If the dollar continues to appreciate at the rate it has been, and if it continues to do so because we continue to raise rates, that cannot be paid off."

"At some point, there will have to be some kind of intervention," Rubenstein added. The Mexican peso was the worst-performing EM currency last year, depreciating by 20% alone on the news Donald Trump had been named president-elect.

Weber disagreed that such drastic action would be needed, and said he hoped central banks were not reverting to "the world of intervention". "If we use currency intervention to move prices in the currency markets, we are getting back to very bad modes of intervention," he said.

Face of the new Fed

Instead, the former Bundesbank governor argued the Fed was more likely "to look a lot more at traditional monetary policy rules" than pursue "discretionary intervention in the market" under the incoming Trump administration.

The Fed is currently a largely Obama-elected organisation, with five of the seven seats of the board elected by the outgoing Democrat. Since the election of Trump, there has been speculation about who he will appoint to the remaining seats on the board and the likelihood of Janet Yellen remaining at the Fed when her term comes to an end next year.

Janet Yellen’s term as Fed chair is due to come to an end in February 2018

"What everyone wants is an independent Fed. The 104 years of independence has served the US and the global economy well," said Anthony Scaramucci, a member of Trump's incoming administration.

Weber said there was likely to be "a complete change" within the next 12–15 months in the economic philosophy at the central bank. Obama only filled five of the seven seats, with a number of candidates not being passed through the Senate. The positions of chair and vice-chair will also be made vacant in 2018.

Weber admitted Trump was likely to appoint people with different economic priorities to the current board, but argued the new president's selection would not affect independence.

Independence was a key concern for all members of the panel, which also included Swiss National Bank governor Thomas Jordan and Li Daokui, professor of economics at Tsinghua University.

"Central bank independence is a core issue," said Jordan. "Countries which lose independence will suffer over time, and I am deeply convinced over the long run it is important to maintain it."