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. All of this would affect the US economy sooner or later through some combination of lower demand for its exports, more uncertain supply chains, financial losses and greater national security concerns.

The US cannot do much to directly counter the drivers of currency weakness elsewhere. But it can — and in fact should — do two things in response.

First, it should intensify the domestic policy effort to ensure that the (highly likely) outperformance of the US economy is accompanied by safeguards against disappointing absolute performance. This, most importantly, involves the Federal Reserve battling inflation more effectively, enacting additional pro-growth and pro-productivity structural measures, offering greater protection for the most vulnerable segments of society, and enhancing supervision of non-banks.

Second, the US should lead the way in coordinating with allies on policies to contain the scale and scope of damage to the global economy. There is a fallacy in the current inclination of so many countries to “self-insure” against common global shocks in the absence of proper multilateral cooperation. The more this continues, the greater the overall pressure on everyone.

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A strong dollar helps the US to reduce imported inflation, but it is far from a panacea. Too big a currency shock risks undermining and, in some specific aspects, destabilising a global economy that is yet to fully come to grips with the consequences of declining growth and high inflation.

Bloomberg

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