Those most at risk from the dangers of a strong dollar are not in the G7 at all but are, instead, in emerging market countries.

Japanese officials have been bemoaning yen weakness recently and trying to ensure that G7 Finance Ministers remain committed to the observation that disorderly exchange rate movements are unwelcome. This they did at the recent meeting, but there seems little appetite to support Japan’s cause and presumably even less to engage in broad intervention. But does that mean that all action to prevent a rising USD is off the table?

Mr. Steve Barrow, Head of Standard Bank G10 Strategy argued that intervention would be wrong now, and conceivably in future months because the world essentially needs a stronger dollar. This need arises out of the fact that inflation has risen sharply and this requires a tightening of global financial conditions. The US is front and centre when it comes to delivering this because it dictates what is commonly called the global financial cycle thanks to the dominance of the dollar in things like the global payment system, FX trading, currency reserves and international debt denomination.

In other words, when global financial conditions need to be tightened, the US can effect this by raising its own rates and so creating dollar strength that pressures other countries to follow suit (or else suffer sharp currency weakness). Of course, non-US central bankers around the world also know that policy needs to be tightened and are doing so even if the stronger dollar is not forcing them into such action.

However, it would still be wrong now to let the world off the inflationary hook by intervening to supress the dollar. This being said, there might clearly come a point in the future where the tightening of financial conditions created by dollar strength becomes too onerous and has to be turned around.

Many might think about this in terms of certain levels for the major currencies. For instance, would parity for the euro/dollar be sufficient for action, or the historical lows of around 82 cents seen in 2000? In terms of dollar/yen, would Japanese officials push for coordinated action if the dollar were to scale 150? There might be all sorts of conjecture about the levels of major currencies that could prove a trigger point for governments and central banks to consider action, but, in Mr. Steve Barrow’s view, this misses the point.

For starters, Japan may claim that the dollar/yen at – say – 150 is intolerable, but is this true? Mr. Steve Barrow thinks that those most at risk from the dangers of a strong dollar are not in the G7 at all but are, instead, in emerging market countries.

As the IMF and others keep reminding us, the greatest difficulties are likely to be felt in emerging markets given things such as high food and energy prices – and high debt levels. It is this increase in debt that seems to leave countries exposed to dollar strength, most obviously in those cases where the debt is largely denominated in the dollar. Hence it seems to us that if the dollar does keep rising swiftly the judge and jury of intervention should really lie in the degree of stress that it is causing for emerging markets, not in the likes of Japan or the euro zone. And should coordinated intervention decisions be left to the rich G7 countries, at the expense of broader alliances, such as G20, the cost could be insufficient action and excessive hardship in emerging markets.

“We are not suggesting that the Fed and other major G7 nations should sell dollars against emerging market currencies. Intervention would still be in the likes of the euro, yen Swiss franc etc, but the aim would primarily be to bring about a lower dollar generally, including most importantly against emerging market currencies”, Mr. Steve Barrow said.

But just how realistic is this scenario? Mr. Steve Barrow said it would seem very unlikely, at least now, or probably anytime soon. But he doesn’t know how far or how long this stagflationary threat will last and how strong the dollar could get. If Fed tightening tends to lead to recessions, then that maybe because financial conditions tighten too much via excessive dollar strength. A similar scenario now could easily force major policymakers to look at intervention in the future – but for the benefit of EM countries, not the likes of Japan.